Augusta Rule: Homeowners Can Earn Tax-Free Income

Paying taxes isn’t fun. It’s a pain. The pain is why most real estate investors jump at opportunities to earn tax-free income using the Augusta Rule.

The Augusta Rule, or IRS Section 280A, applied to the residents of Augusta, Georgia, who would rent out their homes to attendees of the golf tournament.

Do you want to know more about how the savviest of real estate investors leverage this tax rule to their advantage? Read on to learn more about the Augusta Rule and its potential benefits to your real estate investing business. (This topic was also featured during our Royal Tax Group Mentoring; if you prefer to watch a video replay of the presentation follow this link and jump to 26:00 minutes in: Homeowners Can Earn Tax-Free Income with the Augusta Rule.)

What Is The Augusta Rule?

As mentioned, the Augusta rule originated with people renting out their homes. Subsection (g) of the code reads in part, “if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is rented less than 15 days during the taxable year, then the … income derived from such use for the taxable year shall not be included in gross income.”

The rule applies to any taxpayer who owns a home in the U.S., provided that your home is not your primary place of business. One thing to note here is that the presence of a home office does not make your home your primary place of business.

The Augusta Rule IRS exemption applies to your (the owner):

That means you can rent out your residence for fourteen days and earn rental income but not have to report that income on your federal taxes.

How Does The Rule Work?

The Augusta rule works when you rent out a dwelling unit as a personal residence.

Here is a list of assets that are personal residences for Augusta Rule purposes:

You may qualify for the exclusion as long as you use that dwelling unit as a residence. While you can earn money through the rule, expenses related to your property rental are not deductible.

There is a 14-day limit on the number of days you can rent your property before claiming the rental income on your federal taxes.

What Is The 14-Day Rule In The Augusta Rule?

The rule has a provision that states you can only exempt 14 days of rental income from your taxes. On day 15 of rent, you have to report the entirety of the rental income to the government and get taxed accordingly.

The 14 days are cumulative, not consecutive. That matters because it gives you flexible options to generate rental income. For instance, at Super Bowl LVI in Los Angeles, a person who lived adjacent to Sofi Stadium rented their 2,500-square-foot home for $10,000 over the football weekend.

You may not see the same extreme prices, but there are plenty of ways you can maximize your rent for those 14 days. You might consider matching your rentals when an influx of visitors creates a spike in demand, including:

It would be best to charge a fair rental market price and avoid possible legal snags. To help you set the right rental market price:

An advantage of using rental websites is they track rent prices and rental rates that you can present to the IRS should they have questions.

Renting out while your market is hot is a good strategy. Another unique opportunity is having your real estate investing business rent the property from you.

Why Is Using The Augusta Rule Unique For Tax Planning?

The rule lets you shift income from your small business directly to you without paying taxes. For instance, you could rent your home to your small business to receive a tax deduction at the business level and exclusion from the rental income at the personal level.

Here is an illustrative example of how the August Rule could work for you. Suppose Jason is an owner of a small business.

Each quarter, the business rents Jason’s vacation home to hold meetings, strategize, and plan for the upcoming year. In total, the company rents the vacation home for fourteen days. The fair market rental rate for those fourteen days comes out to $10,000.

Jason’s business deducts the rental price as a legitimate business expense of $10,000. Since the company rented for only fourteen days, Jason does not need to report the $10,000 income.

What should Jason and the business do to ensure he does not get in trouble with the IRS?

In the preceding example, Jason potentially saved $3500 in federal taxes.

How Do I Determine The Right Rate?

Remember to call around hotels to get quotes and check out online rental sites like Airbnb, HomeAway, and Vrbo. Remember to look for similar properties to yours. For instance, suppose your house has amenities, like a pool and jacuzzi. It would be best if you found rates for similar spaces with extras, like a pool and jacuzzi.

Here is a list of things that you should consider when getting a quote:

It is critical to maximize the rent for these fourteen days. One way to do that is to remember the preceding list of invisible amenities your home provides.

Key Takeaways

The Augusta Rule is a way that homeowners can earn tax-free income from a residence.

Keep in mind these four fundamentals to maximize your income and minimize your entanglement with the IRS:

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Roth Conversions to a Solo 401K to Offset Losses

Are you a self-employed real estate investor? If so, the solo 401K may be the best option for you. The solo 401K is an IRS-approved retirement plan that enables you to minimize your tax burden. Read on to learn more about how this tax strategy works and how you can offset losses with a solo 401K and Roth conversions.

What is a Solo 401k?

As mentioned, a solo 401K is an IRS-approved retirement plan. Also, the solo 401K is ideal for self-employed business owners or business owners with one other employee, usually their spouse.

This retirement plan allows contributions of up to $60,000 each year.

If you want to learn more about the solo 401K and its many benefits, read our informative guide: Solo 401K vs. Self-Directed IRA: Which Is Better For You?

What is a Roth IRA conversion?

A conversion is a taxable movement of cash, real estate, or other assets from a Roth IRA to a Solo 401K.

When you convert from a Roth IRA to a solo 401K, there's a tradeoff. You will face a tax bill, possibly a big one, due to the conversion. If you decide to convert a portion of your Roth IRA conversions into a Solo 401K, you will pay taxes on the money you convert.

However, you'll be able to secure tax-free withdrawals as well as several other benefits, including no required minimum distributions, in the future. With proper tax planning, you may even be able to mitigate the tax bill from the conversion.

All in all, you pay taxes on the money you convert to secure tax-free withdrawals and several other benefits. One of the most significant benefits is that you will no longer have the required minimum distributions in the future.

Why are Roth conversions a popular tax strategy?

Roth conversions remain popular as many taxpayers fear that tax rates will only increase in the next few years. A Roth conversion enables you to convert now at lower tax rates, let your account grow, and let you make a tax-free withdrawal over the life of your retirement!

How is a solo 401K different from a traditional IRA or 401(k)?

Remember, if you have a traditional IRA or 401K, that money grows tax-deferred, but you pay tax on the distributions as you withdraw the funds at retirement.

The tax rate might be much higher when you retire. That means you would potentially lose more money to taxes each time you make a withdrawal.

Another thing to remember is that once you reach age 72, you must withdraw a certain amount of money each year, or the "required minimum distribution."

How can I offset losses with a Roth conversion?

One of the ways to mitigate the tax impact of the conversion is for a business owner to offset net operating losses (NOL). The income generated by a Roth conversion may offset the NOL, and the business owner may not incur any additional tax liability. Additionally, there is no limit to the amount of income that an NOL can offset.

What is a net operating loss?

Generally, a net operating loss (NOL) is an excess of deductions over income from the operation of a business. These deductions are expenses from the operation of a business.

For individuals, an NOL may also be attributable to casualty losses. A casualty loss occurs from the destruction or loss of your (taxpayer's) personal property. The casualty loss is a single, sudden event.

For instances of theft, you will need to prove that someone stole the property.

Example of how you would offset losses with a solo 401k

First, a disclaimer: these calculations can be complex, and investors should consult with a tax professional or financial advisor to decide the best strategy for them.

The following example illustrates the calculation.

INCOME

Spouse’s wages
$75,000

Interest and dividends
5,000

Total income
80,000

DEDUCTIONS

Net business losses
(itemized deduction and personal exemptions not allowed in net operating calculation)
(170,000)

NOL for tax year
(90,000)

Income from Roth IRA conversion
90,000

Net taxable income
0

This example is for illustrative purposes only.

In this case, the couple may decide to convert $90,000 from the IRA. Then they can use that $90,000 to offset the loss and possibly avoid generating any tax consequences.

If you want to learn more about how the solo 401K lowers your tax burden, read Self-Directed Solo 401K: How to Avoid Tax Penalties.

Here's The Bottom Line

The solo 401K is probably right for you if you are self-employed. You need to decide if it's the right time for you to convert money in your Roth IRA to a Solo 401K.

If you do decide on a conversion, remember the tax bill upfront secures your freedom from "required minimum distributions." Also, you may be able to offset your losses with a solo 401K.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Tax Savings Strategy to Achieve Financial Freedom

Are you ready to grow your real estate business? To do that, you need a solid tax savings strategy.

You already know that there are considerable advantages to investing in real estate. The passive income, substantial tax savings, and long-term security most likely drew you to real estate investing.

Real estate investing is the first step in your plan for financial freedom. The first thing you need to focus on is finding good real estate deals.

The next step is to maximize how your money works for you. Read our list of six tax savings strategies to achieve financial freedom and build wealth.

#1: Start with the children, house, and vehicle

#2: Maximize your deductions

This tax strategy is primarily for single-family home investors and the available deductions.

You have a multitude of deductions available to you as a real estate investor.

Deductions that do not impact financing Deductions that do impact financing
- Amortization
- Auto
- Depreciation
- 529 Plan
- Home office
- HSA
- SDIRA
- SOLO 401K		 - Business expenses
- Credit card processing fees
- Legal fees
- Office furniture
- Office supplies
- Repairs and maintenance
- Tax prep fees
- Travel expenses

As a sharp real estate investor, you need to know which deductions impact financing because it affects your ability to get loans, secure more properties, and generate wealth.

#3: Start a SOLO 401K

With a SOLO 401K, you can save $58,000 a year in taxes. If you're married, the tax savings increase to $116,000.

How a SOLO 401K works as a tax savings strategy:

Do you want to know more about this powerful tax vehicle? Visit our SOLO 401K Hub to learn more!

#4: Create a Self Directed IRA (SDIRA)

You can add a Self Directed IRA on top of your SOLO 401K.

This SDIRA enables you to manage everything as long as you set up an LLC owned by the IRA. Then, you can invest through the LLC and shelter about $7,000 more per year from taxes.

#5: Use the DB(K) Tax Savings Strategy

The official name of this plan is the Eligible Combined Plan which Congress created as part of the Pension Protection Act of 2006 under Section 414(x) of the Internal Revenue Code.

You can combine the SOLO 401K and SDIRA with the DB(K) strategy. You gain an additional shelter which allows you to grow your wealth with a deferred tax, more capital in play, and higher returns.

#6: Get a Real Estate Professional Designation

If real estate is the primary source of your income or you are a "stay at home" husband or wife, use this strategy.

You can use your depreciation and other losses from real estate to offset other income.

If you are a high self-employed or 1099 income earner, you should consider investing in commercial and multifamily investments. You can use cost segregation, accelerated, and bonus depreciation to avoid taxes.

Even if you are a W2 employee, you have to document your time thoroughly and may be able to secure the designation.

Learn more about the requirements it takes to earn a real estate professional designation.

Tax Savings Strategy Key Takeaways

We went over six tax strategies you need to take to grow your real estate business. These six strategies will help you achieve financial freedom and grow your wealth.

Remember to:

  1. Start with the children, house, and vehicle
  2. Maximize your deductions
  3. Start a SOLO 401K
  4. Create a Self Directed IRA (SDIRA)
  5. DB(K) strategy
  6. Get a Real Estate Professional Designation

We've covered a lot of information that may include concepts that are new to you. To hear this content presented by Scott Smith check out Royal Investing: Episode #1 Tax Savings Strategies on our Wistia channel.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

1031 Exchange Update for 2022

Are you fed up with paying taxes on your hard-earned real estate profit? Are excessive taxes preventing you from securing your financial freedom as a real estate investor? If so, you should read further to learn more about the 1031 Exchange update for 2022.

As a savvy real estate investor, you can use this little-known tax break to increase your wealth. Once you've mastered the 1031 Exchange, you'll see an increase in your purchasing power as you keep your money working for you and not filling the federal government's coffers.

What Is A 1031 Exchange? 

First, you have to know what we mean when talking about a 1031 Exchange. In general, a 1031 Exchange is a tax provision that lets you sell an investment property, take those gains from the property, and reinvest those gains into another property without paying taxes. 

When you sell real estate and earn gains, you have to pay tax. Appreciated property means more tax when you sell. The flip side of that is true too. If your property depreciates, you are subject to depreciation recapture taxes when you sell. Those taxes apply to you whether you claimed the depreciation deductions on your taxable income or not. 

Either way, the federal government will try to extract their pound of flesh from your gains. 

The beauty of the 1031 Exchange provision is that you get to defer the taxes on your gains. That means as a real estate investor you pay no taxes when you sell your property and exchange it for a new real estate investment. If you follow the rules, you may be able to defer the taxes indefinitely as you reinvest into bigger or better properties. 

If you want to learn more about the finer details of the 1031 Exchange, we recommend that you read Understanding 1031 Exchanges And Asset Protection Entities. 

What Is The 1031 Exchange Update? 

When President Biden won the election, one of his campaign promises was to eliminate the 1031 Exchange because of the perception that it gave an unfair advantage to the ultra-wealthy. 

The Biden administration had planned on either eliminating the 1031 Exchange program or modifying it somehow. One of the planned changes was the complete overhaul of the 1031 Exchange program, but that plan hasn't come to fruition. 

The other plan included a $500,000 limit on the amount of money exchanged per year. That plan has also failed to earn widespread support.

One of the reasons the government failed to eliminate the 1031 Exchange program is that it is not in their best interest to kill it. Here's why. 

If the government were to limit the 1031 Exchange successfully, it would mean less tax revenue in the long run. In the short term, the government would enjoy the taxes from the sale of the property.

However, a limit or drastic change to the 1031 Exchange would probably chill the real estate industry. That means that more people will hold onto property to avoid taxes. When people hold

onto their properties, all the ancillary sources of tax revenue dry up. 

That means the contractors, cleaners, attorneys, real estate agents, and title companies do not participate in those deals. When you eliminate those people from transactions, you eliminate the taxes they would have paid. On balance, the federal government earns less in tax by removing or reducing the effectiveness of the 1031 Exchange benefit. 

Fewer taxes and political gridlock have prevented any significant changes from the tax code yet. However, as a competent real estate investor, you should prepare for changes, just in case. That means you should look into all tools available to you right now and take advantage of them. 

You might wonder if the 1031 Exchange is the right investment strategy for you. Answer that question by checking out Is a 1031 Investment Strategy Right For Me? 

Key Takeaways

The 1031 Exchange update doesn't take away from the fact that it still might be the right vehicle for you to avoid paying capital gains taxes. Right now, there is talk in Washington D.C. about making policy changes, but nothing has emerged from those discussions yet. 

That's not to say that nothing will happen, but a lack of support and institutional gridlock are keeping policy changes at bay. As an intelligent real estate investor, you should plan, but don't worry too much about things out of your control. 

The best thing to do right now is to use all your tools. That means finding out which real estate investment strategy is suitable for your particular and unique circumstances. 

Do you have a plan for your financial freedom? If not, let us show you how to secure your financial independence and build generational wealth to pass on to your family. 

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Real Estate Professional Designation

As a real estate investor, you have to contend with mortgage payments, repair and maintenance, insurance, and other myriad fees. On top of all of those fees, you still have to pay tons of taxes—capital gains, net income investment, and income.

Sometimes, it’s hard to carve out profitability, and you want to have all the weapons in your arsenal to combat your tax burden.

Sound like you? You’re in the right place.

This article doesn’t list every tax break you have available to you as a real estate investor.

What is in this article is a tactic that works. Establishing a real estate professional designation for yourself reduces the amount of tax you owe, improves your cash flow, and acts as a step toward securing your financial freedom.

Why should I get a real estate professional designation?

The short answer is that it might save you money. It’s essential to determine whether your involvement in real estate activities makes you a real estate professional for tax purposes.

First, the real estate professional designation establishes if you can deduct losses from your real estate activities against ordinary income. Second, it determines if your income from real estate investing is subject to the net investment income tax.

What are the rules that determine the deductibility of real estate losses?

IRS Sec. 469(c)(2) states that rental activities are considered passive activities regardless of your level of participation.

That is important to you as a real estate investor because:

That means your passive losses from those activities are only deductible against your passive income activity income.

However, if you qualify as a real estate professional, the passive activity loss rule doesn’t apply to you.

That enables you to deduct losses from rental real estate against nonpassive income. Examples of nonpassive income include:

You have the potential to reduce your taxable income close to zero and increase your cash flow.

A net investment income tax of 3.8% applies to income over the threshold amount. The threshold amount is:

However, there is an exemption for gross rental income from being included in investment income for real estate professionals.

What constitutes a real estate professional?

You, as a taxpayer, qualify as a real estate professional for any year as long as you pass three tests with your real estate business:

Test 1: Material participation means that you participate through the year on a regular, continuous, and substantial basis. There are seven ways you can “materially participate,” so finding a way to qualify is surprisingly easy.

Test 2: You must spend at least 750 hours per year in real property trades or businesses in which you materially participate. Personal services performed as an employee do not count unless you (as the taxpayer) are at least a 5% owner of the trade or business.

Test 3: You must spend more than 50% of your working time on real estate activities in which you materially participate.

For the real estate professional designation, an actual property trade or business includes, but is not limited to:

If you meet the requirements of the three tests and have documented proof, when you file taxes, you will file an IRS Section 469(c)(7)(A) Election to Aggregate Rental Real Estate Activities. The election is a written statement sent with your return for the tax year of the election.

Why should you become a real estate professional for tax purposes?

The IRS recognizes three categories of real estate investors. The third category, “real estate professional,” enables you to deduct 100% of your real estate losses against ordinary income. You can even deduct your real estate losses against your spouse’s income!

You might have one rental property or several properties. As a property owner, when you take the real estate professional election, you can create thousands of dollars in tax deductions. Those tax deductions may result in no tax liability at the end of the year.

Key Takeaways

As you will quickly learn, real estate has incredible potential with the sheer number of tax breaks to create cash flow.

One of the top strategies that savvy investors use is qualifying as a real estate professional.

As a real estate professional, you can:

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Year-End Tax Preparation: What You Need to Know

Are you ready for year-end tax preparation?

It's hard to believe that there are only a few days left between you and 2022. As 2021 ends and you forge your path forward into 2022, you must undertake some housekeeping to close out 2021 and start 2022 in the best position possible as a real estate investor.

As a real estate investor, it might not seem that there is much to do. However, each year, you need to assess your plans, goals, and the state of your investments. Before the year closes out, make sure to go over this essential end-of-year checklist.

To prepare for tax season, we strongly suggest you:

Read below to find out the best ways to accomplish the preceding tasks.

#1 Organize Your Tax Documents for Year-End Tax Preparation

You want to make sure you prepare everything for filing. Tax day seems far off in the distance, but April 15th comes fast in reality. As a result, it's never too early to get your documents in order.

Right now is the optimal time for real estate investors to collect all documents related to filing taxes. Some things you can do to make this process easier includes:

Ensuring that you have all your taxes settled ahead of time reduces stress and allows you to move past the financial commitments of 2021 and focus on growing your business in 2022.

Paper receipts can be burdensome, so it might be easier to pull out your bank records and highlight all your expenses. Some apps make tracking expenses more manageable. We like Expensify.

#2 Optimize End of Year Deductions for Year-End Tax Preparation

You plan on growing your business in 2022. One way to maximize your deductions is to purchase business vehicles and additional assets. Then you can schedule business meetings. Then, claim them as expenses on 2021's taxes.

As the year ends, you want to recheck your deductions to get your taxable income as close to zero as possible. One of the ways to lower your tax responsibility is to file deductions. You can file deductions on:

Being a real estate investor comes with plenty of tax deductions. The following list is not comprehensive but provides you with some ideas of what you can deduct in addition to the standard deduction:

It's hard to maximize your profit if it's getting eaten up by all the sales, properties, federal income, and state income taxes you must pay. As a savvy real estate investor, you need to finesse your documentation and deductions and realize the benefits of being a landlord.

An easy way to make sure that you are optimizing your end-of-year deduction is through Royal Legal Solutions' Peace of Mind Program. We hold all your tax accountability through the program, work with your account executive and CPA to maximize deductions, and shelter your assets.

Contact [email protected] to learn more about how the Peace of Mind Program will protect you and your assets.

#3 Prepare Your LLC for Tax Season

As a real estate investor, you know the importance of having your assets protected by an LLC. Depending on where you do business, having an LLC means paying a yearly franchise tax.

The franchise tax is a required fee that your LLC pays for the right to do business in any given state. This tax is separate from other federal or state income taxes required by government entities.

Franchise taxes are required:

In addition to franchise tax considerations, as an LLC owner, you will want to:

Key Takeaways

When you began your real estate investing journey, you had a set of goals in mind. Now is the time to revisit those goals, assess your performance, and make needed adjustments to accomplish your goals.

As you enter the new year, you should focus on growing your business. That means putting 2021 tax burdens behind you. Make sure you finish 2021 strong by having a clear and detailed plan where you:

A solid plan in place will allow you to earn more and grow your real estate portfolio.

To learn about powerful tax savings strategies that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Are You Deducting All the Business Travel Expenses You Qualify To?

Business travel expenses add up quickly and negatively impact your cash flow. Losing money to taxes and other unforeseen circumstances makes being a real estate investor demanding sometimes. Safeguarding your venture has to be one of your top priorities. Do you want to make sure your real estate investing business is protected? Start with our investor quiz, and we'll help you find ways to protect your assets.

For a self-employed real estate investor, tax laws can be confusing. Some IRS tax codes are straightforward; others are a little quirky.

In this article, we'll look at some business travel expenses and allowable deductions.

Opportunities for Useful Travel Tax Deductions

If you are a self-employed taxpayer and meet specific criteria, you can deduct most of your travel costs.

For example, you can deduct business travel expenses away from your home if the trip's primary purpose is business or business-related. Those expenses include, but are not limited to:

Maybe you hate to fly; you can also deduct for travel occurring via:

Even if you mix business with pleasure, you can still deduct the trip's expenses, provided it passes the "primary purpose" criteria.

Shrewd Business Travel Reimbursement Secrets

The "primary purpose" criteria mean that your trip's primary purpose must be business--it cannot be an undercover vacation. To make your case that your trip was a business trip and not for pleasure, you must provide evidence that you spent more time on the business than leisure.

That makes the number of business days as opposed to personal days incredibly important. One of the things in your favor as a self-employed taxpayer is that the days you spend traveling count as business days.

Here is a brief illustration of the "primary purpose" point:

Mr. Johnson is a self-employed taxpayer. He leaves for a business trip on Monday. Johnson inspects properties, draws up contracts, and closes deals on Tuesday, Wednesday, and Thursday.

Mr. Johnson relaxes and enjoys the city on Friday, Saturday, and Sunday before flying back on Monday. In total, Mr. Johnson was on an eight-day business trip.

Based on the illustration, Johnson spent five days on business:

Easy Tax Deductions: Travel Expenses' Surprise Rewards

You can creatively leverage the tax code in your favor. For example, you decided to take a business trip, and your non-employee spouse wants to come along. You cannot deduct the expenses attached to your spouse, but you can subtract the total of what you would have paid alone.

Another thing that the IRS allows exemptions for is meals as long as they are:

The most important thing to consider when deducting meals is a precise documentation of the meals:

Your thorough documentation is the evidence you need to justify a tax deduction.

The Truth About IRS Commuting Rules

You should know about IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits. In the guide, there is a section about working conditions fringe benefits. An applicable tax exemption is the business use of a company vehicle.

Mileage Deductions

You can deduct the total mileage driven in a tax year multiplied by the standard mileage rate of $0.56 (down 1.5 cents from 2020).

Another option is calculating an itemized list for vehicle expense which may include:

Just like for meals, your documentation must be thorough and accurate.

Commuting

Another IRS rule you should know is Topic No. 511 Business Travel Expenses, also called the "away-from-home rule."

Home for tax purposes is the tax home, not your actual home. The tax home for your business is the general area where you (the taxpayer) conducts business.

The IRS uses the term "away-from-home" to describe taxpayers who are not within commuting distance from home. If you work away from home for more than a typical workday and require sleep, the related costs are tax-deductible.

In contrast, if you work within commuting distance from home (and are away from home) but decide to sleep away from home--those costs will not be deductible.

However, if you do not follow the rules, everything is still deductible by you (the employer). The reimbursement will then be added to the employee's taxable wages and subjected to payroll withholdings and FICA.

Keep a Business Travel Expenses Log

An "accountable plan" requires the employee or business partner to provide justification and adequate proof of all expenses during job-related travel. This plan lets you (the employer) properly deduct these expenses (assuming you provided receipts!).

When reimbursements are made from the employer to the employee without an accountable plan, they are taxable. The employee will need to file a miscellaneous itemized deduction (Form 1040). These deductions will need to be made under Schedule A on the form and are subject to a 2% AGI nondeductible threshold.

As a result, the employee will not be able to deduct some or all of the expense. If the employee must file deductions for lodging and meals, they must be away from home for at least one night (per the away-from-home rule). Any travel that lasts longer than a year will likely be unable to be deducted.

As the employer, you can deduct business expenses that are "ordinary and necessary." These expenses include job-related travel and lodging expenses.

The Bottom Line, Simplified and Direct

  1. Keep thorough documentation.
  2. You can deduct business travel expenses from your tax responsibility.
  3. Mixing business and pleasure is fine, but only deduct business expenses.
  4. Traveling is a business expense.
  5. Business meals and staff appreciation meals are deductible
  6. Finally, make sure that you know the IRS rules for fringe benefits and business travel expenses.

Minimize Taxes through Cost Segregation

You want to protect your assets, and you want to protect your wealth. Cost segregation is a form of wealth protection, as discussed in the video below.

Cost segregation is a tax strategy available to the following:

This strategy creates an income tax benefit for you and generates increased cash flow.

In this article, we will answer the following questions you might have:

Like you want to protect your wealth, you want to protect your assets. Lawsuits can be catastrophic and painful, and insurance provides insufficient protection to you. Unfortunately, your equity in real estate is a lawsuit magnet--unless you're protected.

Do you want to make sure your real estate investing business is protected? Start with our investor quiz, and we'll help you find ways to protect your assets.

Your assets generate cash flow and are essential to your financial freedom. That's why understanding how to increase your income through cost segregation is so crucial. Continue reading more and learn about this effective tax strategy.

What is Cost Segregation?

You want to keep more of your money—cost segregation lets you do that. As Yonah Weiss says, "It's not about how much you make; it's about how much you keep."

Cost segregation benefits you by:

Real estate depreciates over time. As a result, the IRS enables owners of real estate investments to deduct an amount from their income every year before taxes are assessed. This deduction is called a depreciation expense.

You don't pay the depreciation expense out of pocket. Instead, you claim the fee and have less of a tax burden on your income. Cost segregation maximizes the amount of depreciation expense by accelerating the decline of your property's value.

How is Depreciation Calculated?

First, there are fundamental rules about calculating depreciation:

For example, you can calculate straight-line depreciation, which means you research and identify how long, in years, your asset will take to crumble completely. The number of years during which your property is in good enough condition to be used is called useful life.

Then, you take the amount you paid for your investment and divide it by the number of useful life years. Finally, you claim that amount ($ amount of investment # of useful life years) each year.

The IRS determines that the useful life for single and multifamily rentals is 27.5 years, and commercial properties last for 39 years.

Generally, when you buy a property, you purchase the building and the land underneath the building. Remember--land does not depreciate--so you can't just take the sales price of your property and divide it by the number of useful life years.

You have to separate your purchase price into two components:

Then you can divide the price of the building by the number of useful life years to determine your annual depreciation expense rate.

What is Accelerated Depreciation?

In general, the interior and exterior components of a building are classified as either commercial or residential. Commercial assets depreciate over 39 years, and residential properties depreciate over 27.5 years.

The IRS gives you different time frames for how long different things last. Just like you split the price of your building and land to calculate your depreciation expense, you can further split up the components of your building to take advantage of the tax code.

Remember that depreciation is calculated by (price useful life years). When the total lifetime of an item decreases, the annual depreciation rate increases. As you reclassify the IRS category in which your property belongs, you have the chance to claim a shorter useful life of the item.

Consequently, you accelerate the amount of expense in the early years of your ownership. In other words, your property is subject to accelerated depreciation. The higher the depreciation expense means that you have less taxable income and a smaller tax bill.

Here are the ways the IRS categorizes property and depreciation:

Key Takeaways about Cost Segregation

  1. Cost segregation saves you money on taxes by increasing the amount of depreciation expense you can claim.
  2. When you pay less to the IRS for taxes, you have an increased cash flow.
  3. That increased cash flow enables you to reinvest in your business and secure your financial future.

Determining which category your property falls into is not easy, and if you make a mistake, you may end up on the IRS' radar. That's why it's a good idea to get a cost segregation study from experienced professionals. Usually, it's a team of accountants, attorneys, and engineers who conduct the survey and determine where your property should be categorized.

Tax-Free Real Estate Investing: How To Get Started

Scott Smith, Royal Legal’s founder, and lead attorney, recently sat down with real estate investor J. Darrin Gross to discuss tax-free investing on Gross’s Commercial Real Estate Pro Network Podcast. 

The delightful discussion covered not only the possibilities of tax-free investing in real estate but also how real estate investors can protect their assets. You can click the link above to listen or read on to learn more. 

Tax-Free Investing vs. Tax-Deferred Investing

“Tax-free” investing is better thought of as “tax-deferred investing.” Whether you invest in a traditional 401(k) that taxes withdrawals or a Self-Directed Roth IRA, which taxes funds before use, the tax doesn’t just disappear. It’s a question of when the tax is paid.

You can accelerate the growth of your retirement account using either a Solo 401(k) or a Self-Directed IRA. In a nutshell, with tax-deferred real estate investing, you lend yourself money from your own Solo 401(k) that doesn’t have to be repaid until you retire.

How does this work in terms of W2 income?

Anyone with a W2 (employer) income can create their own 401(k) or IRA account. But with non-W2 income, one can take advantage of creating a Solo 401(k) that allows you to defer taxes.

What is a Solo 401(k)?

If you have non-W2 earnings and can demonstrate that you’re an “active” investor, you may qualify for a Solo 401(k). If you structure an entity properly and demonstrate that you are active in its operations, multiple advantages become available. You have to be able to deposit up to $50,000 annually and be in a position to borrow up to 50% of that balance without creating a taxable event. Royal Legal Solutions helps clients set up a Solo 401(k) to run themselves. 

What is the advantage of a Solo 401(k)?

The advantage is that you only have to pay it back by the time you retire. So, for example, you can take $50,000 and put it into your 401(k) tax-free and loan yourself $25,000 of that to invest in anything you want.

You still owe that money back to your 401(k), but you don’t need to pay it off until you retire. In the meantime, you’ve got $25,000 in tax-free money in your Solo 401(k) that you can invest immediately.

Does passive real estate qualify?

No, it’s not legal to set up a Solo 401(k) with passive income. But you can open up your own property management company. Doing this turns passive income into active income. 

Setting up a property management company for a Solo 401(k)

You can establish an S Corporation to be your property management company. As the sole employee of that S Corporation, you can then set up a Solo 401(k). There are a few inexpensive legal steps to this process, and Royal Legal Solutions can help set up a Solo 401(k) for you.  

Do I need to be a real estate professional to have a Solo 401(k)?

No, you just need to be earning active income. The income cannot be classified as passive. But passive income is easily converted into active income by setting up a real estate company, which can then be used to establish your Solo 401(k). The restrictions are light - you just have to be the sole employee of your own company to meet the conditions of a Solo 401(k).

Once you have set up the company, you can channel $50,000 per annum of non-W2 income into the company. That amount pays into the Solo 401(k) up to the $50,000 mark, and all of that is tax-free for now. 

The advantage of investing with pre-tax dollars instead of post-tax dollars can typically be a 20-30% bump, and that’s where the actual returns are. You get a pretty significant increase in your investment amount this way, without much risk.

Should I invest with a Self-Directed IRA?

Income from a Self-Directed IRA LLC is also tax-deferred, meaning real estate investments can be made tax-free. The tax is paid later instead of paying tax on the returns of a real estate investment. This allows investors to select the assets they want to invest in, except for “prohibited transactions,” such as collectibles and life insurance.

Tax-Deferred Investing: The Takeaway

Tax-deferred investing is important to real estate investors because it allows them the available funds to buy property from their own Solo 401(k) without paying back a loan to a bank or other financial institution. Essentially, you owe the money you’ve borrowed back to your retirement account, in effect turning yourself into your bank. The difference is that you are an active business, not a passive generator of income.

If you start with tax-deferred investing in your 30s and you don’t have to pay the loan you took from yourself back for another 35 years, your wealth curve will likely have been on an upper trajectory, making it easier to pay the loan back at retirement. Having money available makes a real difference to your ability to invest in real estate today for profit in the future. Unlike using a credit card, the debt here makes more money in the short term, which will pay down later debts more quickly.

Royal Legal Solutions: Helping You Grow Investments Tax-Free

Royal Legal Solutions has tax-saving strategies for everyday real estate investors. Royal Legal Solutions can help you form a legitimate strategy to protect assets.  If you are a real estate investor anywhere in the United States and want to learn more about tax-free investing and tax-deferred investments, start with our investor quiz, and we'll help! We are the one-stop shop for tax, legal, and business advice for real estate investors everywhere.  

Using Your C Corporation’s Tax Brackets To Reduce Your Tax Burden

Every real estate investor or business owner knows that taxes take up a big chunk of profit and earnings from investment income and capital gains. Understanding how the tax system and tax brackets work may help you reduce your tax burden and liabilities.

As a real estate investor, you may be able to minimize income taxes either by hiring family members or your C corporation. This article focuses on the possible tax benefits of outsourcing business contracts to a C corporation owned by you.

Interested in learning more? Check out our article, Using Your Family’s Tax Brackets To Reduce Your Tax Burden.

How the progressive tax brackets work

Progressive tax brackets start taxing the lowest amount of income at the lowest rate. The tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner; likewise, low-income earners pay at a lower rate.

Here’s a (hypothetical) example of how progressive tax brackets can work:

An annual income of $100,000 puts you in the 20% tax bracket. Note: The tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%.

Using Your C Corp’s Tax Brackets

Similar to individual income taxes, C corporations have tax brackets. This is how it generally works:

  1. The first step is to set up two businesses. One would be set up either as a sole proprietorship, a partnership or an S corporation. This business would be your main real estate business, operating as a pass-through entity. The income you get from this business is taxed at your individual tax bracket. The second business you set up will be taxed as a C corporation.
  2. The next step is to hire your C corporation for tasks that can be justifiable and with payments that are reasonably within market rates. This can include things like property management, cleaning and maintenance or even digital marketing services.
  3. When you pay your C corporation for fulfilled and completed contracts, this counts as eligible expenses that can be deducted from your pass-through entity income. The goal is to transfer this income from your higher income tax bracket to a lower business tax rate. So if your individual tax bracket is at 40%, you can potentially transfer income from your pass-through entity real estate business to your C corporation, which can be taxed at a lower rate of say, 25% (for example).

Things to consider when using a C corporation to minimize taxes

Ordinarily, all of these money movements can be complicated, therefore it is important to keep constant records of all expenses, payments and transfer of income. All contracts and agreements should be documented appropriately. You may need an accountant to ensure this is done properly.

How to manage income from your C corporation

You are probably wondering how effective it would be to use a C corporation to manage and reduce your taxes and how to go about receiving your income from this business. Well, this is a valid concern and there are various ways to go about it, some more tax efficient than others.

In conclusion

If you're looking for ways to reduce taxes on your real estate business, you can explore the C corporation option. While this may require effort to execute, it could lead to potential savings for your business.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Using Your Family’s Tax Brackets To Reduce Your Tax Burden

Effectively managing income taxes as a real estate investor shouldn’t leave you feeling overwhelmed. If you understand how the tax system works, you can find ways to reduce your tax burdens and liabilities. 

A basic feature of our tax system is its progressive nature, which places individuals into different tax brackets based on gross income. 

You can minimize your tax burden by hiring family members, and here I’m going to show you how. First, let’s review the applicable taxes that business owners should know about. 

Types of employment taxes for family members

Bear in mind that when you hire family members, they have to be treated the same way as other employees. The employment taxes that may be applicable to your family members can include:

As we’ll see, when the family members hired to work for the business are children, you can be exempted from some taxes such as the FUTA and FICA. Sometimes, the income paid to minors may be totally tax-exempt.

How progressive tax brackets work

Generally, the federal income tax system is progressive. Tax rates are usually layered and sectioned into tax brackets such that the tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner, likewise, low-income earners pay at a lower rate. 

Here’s a (hypothetical) example of how progressive tax brackets can work:

If a taxpayer’s income for the year is $100,000, he or she falls in the 20% tax bracket. However, the tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%. 

Reduce your tax burden by hiring family members

Now, if you have children or grandchildren in lower tax brackets, there are legitimate ways to leverage their tax brackets to reduce your tax burden. The money you pay them will (because of their bracket) be taxed at the lower rate while bringing your own taxable income level down.

Using the family tax bracket strategy requires that you first identify where it would be appropriate for the family member to be employed. Document the responsibilities that the family member would take on. This does not have to be complex, especially if the family member is not an adult. The roles they fill could be anything from administrative to managerial; even “personal assistant” is fine so long as you document and define the duties.

Since you’ll be transferring income taxes to a child or relative with lower tax rates, there are things to consider:

You should use a payroll company. Don’t do the payroll yourself. As with other business processes and documentations, it is important to keep records for tax purposes. 

Your family member/employee will report the earnings on their tax return. If your family member is a minor, you’ll be filing a tax return on his or her behalf. Wages paid to a child are exempt from payroll taxes if your business is either taxed as a sole proprietorship or a partnership in which the only owners are the parents.

Here’s some more good news … You stand to save even more on taxes if your family member is not currently using their standard deduction!

Final thoughts

Hiring your family members to work for your business can indeed be a win-win situation if done right. This can provide an avenue to keep more income within the family and reduce tax liabilities for your real estate (or other) business ventures.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

When It Comes to Taxes, Is Managing Rental Properties a Business or an Investment?

Whether you are the landlord of a single-family rental or you own a share in a large apartment building, it’s essential to know how to classify this activity at tax time. 

Are you an investor or a business owner?

In this article, we’ll examine the distinction between the two and how qualifying as a business owner can save you money in deductions.

Rentals that qualify as a business

Your rental activity qualifies as a business under the law if you can prove your rentals are “for-profit” and that you work at this business “regularly and continuously.”  

Landlords can hire managers and contractors to do most of the work on their property, but they still must be engaged in running the rentals, according to the law. Also, if a rental unit is vacant, it doesn’t preclude you from qualifying as a business owner -- as long as you are marketing the space for rent.

Here are other factors the IRS uses to determine if your rental activity is a business:

Here are some other ways you can prove you are operating a business with your rental property:

The ‘three of five years’ test

If, as a landlord, you have earned a profit in three of the past five years, the IRS sees you as a business. If you cannot meet this requirement, you must pass the “behavior” test.

The behavior test

You can operate rentals at a loss every year and still qualify as a business owner if you meet the behavior test criteria. Here are the factors an IRS auditor will use in this case:

In order to pass the behavior test, you need to maintain excellent records, including a time log of all your real estate activities. You can establish your expertise through references, blogs, speeches, and podcasts.

Rentals that do not qualify as a business

Landlords often do not qualify as business owners when they do one or more of the following:

What you gain as a business owner versus an investor

For tax purposes, it’s always better for your rental activity to be a business rather than an investment. As a real estate business owner, you can deduct the following:

Landlords who meet the criteria of being business owners may qualify for the pass-through income tax deduction of up to 20% of their net rental income from 2018 through 2025.

This deduction—which is also called the Safe Harbor Rule—is part of the Tax Cuts and Jobs Act (TCJA), the tax reform package that became law in 2018. The deduction will end on January 1, 2026, unless Congress votes to extend it.

Use of the safe harbor rule is optional. To qualify for this deduction, a landlord must:

Landlords who use their rental property as their residence for more than 14 days during the year are not eligible for the Safe Harbor Rule. This requirement means that most short-term rental hosts may not apply for the deduction.

Finally, we cannot emphasize enough the importance of record-keeping as a landlord. Accurate, well-organized records will help you manage your rental property, prepare your financial statements, keep track of your expenses, prepare your tax returns, and support the items you report on your tax returns.

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

How Are Canadians Taxed If They Invest Or Do Business in The United States?

A growing number of Canadians are getting into the U.S. real estate investment game.

According to the National Association of Realtors, Canadian buyers spent $9.5 billion on U.S. residential property purchases during the 12-month period between April 2019 and March 2020. This means that Canada only trails China in the worldwide rankings of foreign investments in U.S. real estate by country.

As more and more Canadians look to acquire U.S. properties, investors must keep in mind the tax implications of purchasing real estate in one country while living in another.

In this article, we’ll explain the ins and outs of how Canadians are taxed if they invest or do business in the States and how you can avoid double taxation. 

How Are Canadians Taxed If They Invest Or Do Business in The United States?

If You’re Canadian, Don’t Use A U.S. LLC

We usually recommend that our clients in the States use a Limited Liability Company (LLC) to manage their real estate investments. Not only do LLCs protect investors from personal liability, but they also offer tax advantages compared to a corporation, allowing owners to avoid double taxation on their business’ profits. 

Under U.S. law, corporations are taxed on their profits, and then employees and shareholders are taxed personally on the income they receive from the business. This means that every dollar the business makes is taxed twice. With LLCs, the business is not taxed separately. Instead, all of the business’s profits are reported as individual income of the LLC’s owners. This is known as pass-through or flow-through taxation.

Unfortunately, both single and multi-member U.S. LLCs are recognized as foreign corporations under Canadian tax law. So, if a Canadian invests through a U.S. LLC, the LLC distributions would be considered foreign income that is not subject to a Canadian dividend tax credit or a foreign tax credit. Rather, LLC income will be subjected to double taxation, eliminating the benefits of pass-through taxation that make LLCs ideal for investors in the states. 

U.S. LLLPs And LLPs Are No Longer The Go-To

For this reason, Canadian investors had traditionally relied on U.S. limited liability limited partnerships (LLLPs) and U.S. limited liability partnerships (LLPs) when investing in the States. Historically, these structures had been viewed as partnerships for Canadian tax purposes and therefore allowed investors to avoid double taxation.

However, in 2016, the Canada Revenue Agency (CRA) announced that going forward, U.S. LLLPs and LLPs would be classified as corporations rather than partnerships. This may mean double taxation for Canadian investors who manage their U.S. investments through LLLPs or LLPs. 

Limited Partnerships Are The Way To Go

Now that LLLPs and LLPs are treated as corporations, the ideal structure for Canadian investors is a U.S. Limited Partnership (LP) structure. Similar to how LLCs work for American investors, LP income is not taxed at the corporate level; it’s passed through and reported on its owners’ personal income tax returns.

Plus, LPs offer Canadian limited partners comparable personal liability protections to LLCs without the double taxation that comes with investing in a U.S. LLC. It’s a win-win!

Avoiding Double Taxation

As you can see, intercountry taxation issues can be messy and complicated. In order to enjoy the tax advantages available through U.S. LPs, Canadians must ensure that the required documentation is drafted and filed correctly. Mistakes could result in substantial tax penalties, forfeiting your liability protections, or even losing your right to do business in the U.S. 

For this reason, Canadians who are thinking about purchasing properties in the States should consult with a  U.S.-based business attorney with experience in real estate investments before making any purchases. A U.S. lawyer can help you minimize your taxes and maximize your profits.

 

 

 

 

 Image by Allange from Pixabay

4 Tax Benefits of Real Estate Investing

If you're a real estate investor, it's no secret that taxes are an essential part of your business. But did you know there are actually some tax benefits to owning property? That's right - not only is real estate investing an exciting and profitable way to cultivate wealth, but it can also help you pay less to the IRS.

Do we have your attention yet? Read on to discover four substantial tax benefits you can enjoy if you get into the real estate investing game!

Benefit #1 — You Can Deduct Your Expenses When You Invest In Real Estate

There are many benefits to investing in real estate, but one of the most well-known is the ability to deduct expenses you incur related to your investment properties. The IRS allows individuals to reduce their taxable income by certain expenses when they file their taxes for that year. This means if you own a rental property and have $10,000 worth of deductible expenses during the course of that year, you can use those deductions on your tax return and reduce your taxable income by $10,000!

Examples of some deductible expenses for investment properties include:

In some circumstances, you’ll be able to deduct additional expenses as long as they are related to your investment properties or your investment company, if you own one. Because everyone’s situation is different, it always helps to consult with a lawyer or tax professional before claiming any deductions.

Benefit #2 — You Can Deduct Depreciation When You Invest In Income-Producing Buildings

In addition to deducting expenses related to your real estate ventures, you can also deduct the depreciation in value that the building structures will inevitably suffer over time, as long as it is considered an income-producing property.

The first step in deducting depreciation is to calculate the value of the building itself without including the value of the land. You’ll then divide the value of the structure by its “useful life,” which, according to the IRS, is 27.5 years for residential buildings and 39 years for warehouses and other commercial properties. So, for example, if a commercial office building you own and rent out is worth $1 million, you can deduct 1/39th of the value (about $25k) in depreciation each year.

Generally, you can only use losses caused by depreciation to offset passive income and not your total income. So if you earned $200K in salary and have one investment property that lost $5K due to depreciation, you could not use that loss to reduce your taxable income from your salary. However, if you made $10K from another property, the $5K you lost can be deducted for a total of $5K in passive income.

There are three exceptions to this rule:

Benefit #3 — You Pay Capital Gains Taxes Rather Than Income Taxes When You Sell Real Estate

When you earn money by selling a property for more than you initially paid for it, the profits will be subject to capital gains tax rather than income tax. If you own the property for a year or less, the income will be considered a short-term capital gain, which means it will be taxed based on your income-based tax bracket.

Long-term capital gains are where the tax savings can start pouring in. If you owned the property for over a year before selling it, the profit you make would be considered a long-term capital gain. Long-term capital gains are subject to 0% to 20% taxes, with your rate of taxation being based on your income. This rate is lower than their income tax bracket for most people, which can save you thousands in tax dollars.

The long-term capital gains tax rates are as follows:

Benefit #4 — You Can Avoid Social Security and FICA Taxes When You Earn Rental Income

Because the IRS considers earnings from rental properties to be passive income rather than active income, you don’t have to pay social security or FICA taxes on your rental income. If you’re employed, you’ll have to hand over 7.65% of each paycheck to FICA, while your employer also pays 7.65%. If you’re self-employed, it’s even worse — FICA will take a whopping 15.3% of your self-employed active income since you’ll have to pay both the employee’s share and the employer’s part. This is called self-employment tax, and it sucks.

Fortunately, Uncle Sam actually cuts us a break for once and considers rental income to be passive. This means it isn’t subject to payroll or self-employment taxes. Paying less in taxes is always great, but on large real estate deals, avoiding that 15.3% self-employment tax can result in significant savings!

Wrapping Things Up

Investing in real estate is a great way to diversify your income and secure yourself some long-term security. We’ve outlined four substantial tax benefits you can enjoy if you get into the game, but there are many more!

If you want to get started in the real estate investment game, we recommend consulting with a business attorney who specializes in real estate investments to make sure you’re taking advantage of all the tax benefits that you can.

Taxes For An LLC: How the IRS Sees Your Limited Liability Company

If you're a real estate investor, you should be aware of how the tax code and the way you structure your business will affect how much money Uncle Sam takes from your bank account.

For example, the IRS has a lot to say about your Limited Liability Company (LLC) and how taxes for an LLC are handled.

If you don't already have one, it's time to create an LLC. Not only does owning your properties and other investments through an LLC protect you from liability, but it can also save you some serious tax dollars if you make the right elections for your business. 

Buckle up! It’s time to learn the basics of how the IRS sees your LLC and what the tax benefits of an LLC are.  

What Is An LLC?

An LLC is a business structure that offers its owners limited liability from the business’s debts. That means if you are the owner of an LLC, your personal assets are protected from any debts or obligations incurred by the company. You and your LLC are considered to be separate legal entities.

This type of legal structure is helpful for real estate investors because it's cheaper and easier to create than other entities like a corporation but still offers the all-so-crucial protection from personal liability.

The people or entities that own an LLC are called its “members.” There is no maximum number of members an LLC can have, and most states will allow single-member LLCs, which have only one member, to be formed.

LLC Tax Classifications

For the purposes of taxes, LLCs are considered “pass-through” entities. This means that LLCs do not pay taxes. Instead, the LLC’s profits are reported on its members’ income taxes. However, depending on the number of members in the LLC and the tax elections chosen for the business, the IRS will treat an LLC as a corporation, partnership, or a disregarded entity.

Disregarded Entities

If you own a single-member LLC, the default tax status for your business is called a “disregarded entity,” which means that the IRS ignores your LLC entirely and just considers its profits to be your personal income. This is the same way that the IRS taxes sole proprietorships. When you file your federal income tax return, you will also need to submit a Schedule C form, which details the profit or loss from a sole proprietorship. 

Many states also allow LLCs to be treated as a disregarded entity when the LLC is solely owned by a married couple. However, if you form a married-couple LLC in a community property state, it will be taxed like a multi-member LLC, so it’s crucial that you do your homework before making any decisions. 

Partnerships

The IRS will automatically tax multi-member LLCs like a partnership, which means that each member will receive a Schedule K-1 and include their portion of the LLC’s profits as taxable income on their personal income taxes. When LLCs are taxed as partnerships, each member must also include a completed Form 1065 for partnership taxation with their tax returns. 

Corporations

Although the default tax classification for an LLC is either a disregarded entity or a partnership, members of an LLC may choose to be taxed as a corporation by submitting Form 8832 (Entity Classification Election) to the IRS. For tax purposes, there are two varieties of corporations- S-Corporations and C-Corporations. 

Like LLCs, S-Corps are pass-through entities, where corporate income, losses, deductions, and credits are passed through to the business’s shareholders for federal tax purposes. With C-Corps, on the other hand, the business itself is taxed, and then each shareholder is taxed again on their earnings when they pay personal income taxes. 

C-Corps are generally not the best choice for an individual real estate investor, but, in some situations, an S-Corp can save you a significant amount of moolah on single-member LLC self-employment tax. 

While you must pay yourself a reasonable salary from the LLC’s profits, you can receive any income your business makes on top of your salary as a shareholder distribution instead of in a paycheck. Because the IRS considers distributions to be “passive” income, you don’t have to pay self-employment/ payroll taxes on the money you receive as a shareholder distribution.

However, this move only pays off if your LLC makes enough income to support a reasonable salary for yourself on top of shareholder distributions. Generally, this threshold is around $75K annually for a single-member LLC, but this can vary depending on your particular circumstances.

What Is The Best Tax Classification For My Business? 

Unfortunately, this is not a question that any blog or article can answer for you. Not even the all-mighty Google can give you advice on this issue. Because everyone’s circumstances are different, we strongly recommend that you meet with a business attorney or tax professional to discuss the tax classification that will save you the most money.

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

Selling a Rental Property: 3 Things You Need to Know

Thinking about selling a rental property? There are a few things you should know before you do. 

For one, the capital gains tax on a rental property is much steeper than it is on a primary residence. 

Also, when it comes to a tenant-occupied property, the process is a little more complicated. Your tenant, after all, still has leasehold rights. 

Finally, "as-is" clauses can protect you from a slew of costly lawsuits.

Now that you've gotten the "tldr" version, let's take a deeper dive ...

Capital Gains Tax: What to Expect

When you sell your property for a profit, you owe capital gains tax. The 2020 capital gains tax rates are as follows:

So, most of the time, you’ll end up paying at least 15-20% for capital gains tax. You’ll also have to pay capital gains tax on the amount that you claimed in depreciation over the course of your ownership of the property. If you claimed over $25,000 in depreciation, and you sold the house for $75,000 more than what you bought it for, then you’ll have $100,000 of total taxable capital gains.

If you just want the money, you’re going to have to pay the tax-man. However, if you’re looking to re-invest, there’s a strategy to avoid the capital gains tax.

Invest in Like-Kind Property

One way to get around the tax bill is to immediately re-invest the money into like-kind property, also known as a 1031 exchange. As long as you choose a new property in 45 days and close the sale within 6 months, the IRS allows you to keep the money you made in escrow, deferring capital gains, until you put that money into a new property.

You could do 1031 exchange after 1031 exchange, never having to pay for capital gains, as long as you hold the properties for longer than 2 years to avoid triggering “dealer status,” according to the IRS.

However, if you realize that you don’t want to be a landlord or you’re trying to raise money for another venture, you’re just going to have to pay the taxman.

Incorporate Your Real Estate Investments

Another way to avoid a sizable tax bill (albeit not entirely, of course) is to incorporate. You might have less access to the gains, but the savings on your tax bill will likely make this a desirable option regardless. There are some serious tax benefits to using an LLC structure. You might want to discuss the details with a qualified CPA.

Incorporating also helps you protect your assets from any liability issues, as well as protecting your anonymity.

How to Sell a Rental Property with Tenants Still Living There

What if you’re selling a rental property but there’s still a tenant living on premises?

The exact laws might depend upon your state, so check the Landlord-Tenant laws wherever the property resides, but you generally have a few options:

The easiest option, by far, is to wait for the lease to expire. You might want to check the lease for an early termination clause. That way, if you can prove that you absolutely need to sell, you might be able to break the lease.

Additionally, you could try to incentivize your tenant to move by offering them cash to cover the cost of moving. This is only a good option if you know that your property is going to sell for much more than you bought it for. If you’re cutting it close, you don’t want to cut it even closer by having to pay to get a tenant to move.

And, finally, you could try to find another real estate investor interested in buying a tenant-occupied property. The downside here is that your property is much less marketable. There’s a wider swathe of possible buyers for single-family homes, but a much narrower market for rentals.

As-Is Clauses Can Protect You From Costly Lawsuits

What is an as-is clause? An as-is clause is a condition clause: the buyer is purchasing the property “as-is.”

It typically states that “the buyer accepts the item for sale in its presently existing condition without modification or repair.” Without it, the buyer is relying upon the seller’s representation of the property. In some cases, that gives the buyer solid footing for a lawsuit.

Now, that doesn’t mean that the seller can engage in any knowingly misleading behavior, or attempt to hide a defect in the property, but it does provide additional coverage in case there are any disagreements. Sometimes there are issues with the property that the seller doesn’t even know about, but that won’t stop some buyers from filing a lawsuit.

To avoid the worst-case scenario, include an “as-is clause” in the sales contract when you’re selling your rental property.

Conclusion: What To Know When Selling A Rental Property

When it comes to selling a rental property, there are three things you need to know: 

1) The capital gains tax for rental properties is not the same as for primary residences, and it can take a serious chunk out of your potential profits. You might be able to avoid capital gains tax (or minimize it) in one of two ways. First, you could do a 1031 exchange. Next, you could incorporate to see if you can take advantage of certain tax benefits.

2) Selling a property with tenants still there is not an easy task.

3) When you do sell your property, make sure to include an “as-is clause” to avoid the potential for certain lawsuits. Interested in learning more? Read our article “The Rental Property Asset Protection Checklist.”

 

How The Qualified Personal Residence Trust (QPRT) Shields Your Home From Estate Taxes

A Qualified Personal Residence Trust (QPRT) is a specific type of irrevocable trust that allows you to remove your primary residence or another personal home from your taxable estate. While creating can be a QPRT complicated process, doing so lets you avoid estate taxes and reduce the amount of gift taxes you have to pay.

And guess what? When the feds take less, your heirs get to keep more of the wealth you’ve worked your whole life to accumulate. 

Keep reading to learn more about QPRTs, and when you're done, check out our article Three Ways To Properly Legally Protect A Personal Residence to discover more asset protection tips for your personal home.

qualified personal residence trust: young child catching football

How Does a QPRT Work?

For estates of several million dollars or more, a QPRT can allow you to keep the value of the home out of part of your estate that is subject to estate taxes. Although the QPRT is not used as often as other estate planning tools, it can save you a significant amount in taxes.

In order to create a QPRT, you have to transfer the title to your home to a trust. However, as part of the terms of the trust, you’ll include a provision that allows you to continue to live in the home for a specific period of time before passing to your heirs. The time in which you can continue to live in the home is known as a qualified term interest or a retained income period. So, while you won’t own your home anymore, you can still live there until this period expires.

How Does a QPRT Avoid Estate Taxes?

While there is technically no limit on how long you can keep your interest in the home, if you pass away before the end of your qualified term interest, the value of the home will be included in your taxable estate. So, you should always make sure the term chosen makes sense given your age and future life expectancy. 

If you survive until the interest expires, the title to the home will pass to your heirs and will not be included as part of your estate upon your death. After your heirs inherit the property, you can pay rent, relocate, or figure out other living arrangements. Any rent payments you make to continue living in the home will further reduce the value of your taxable estate. 

QPRTs and Gift Taxes

Although a QPRT can help you avoid estate taxes, Uncle Sam isn’t going to let you get off scot-free: the transfer of your home is subject to gift taxes. However, since you’re retaining a qualified term interest, the property’s gift value will be lower than its fair market value, which means you’ll owe less in gift taxes.

This deduction can translate to significant savings, particularly when younger homeowners set up QPRTs with extensive qualified term interests. The longer the retained income period, the lower the gift value of the home, the lower your tax bill from the IRS. Just remember that you have to outlive the qualified term interest for your heirs to reap the rewards of your estate planning. An experienced estate planning professional can help you decide on the most strategic term for your situation. 

Another way a QPRT saves you money is by avoiding gift taxes on appreciation. When you transfer your home to the trust, you pay the gift tax on its current value, even though the title won’t pass to your heirs for years to come. That means that any increase in your home’s value during your qualified term interest won’t be subject to the gift tax, which can also save you a substantial chunk of change.  

Why You Should Talk To A Pro

While the QPRT can be a great estate planning tool for shielding your home from estate taxes, it’s not the right solution for everyone. It’s important to keep in mind that specific requirements must be met to qualify for the tax savings. There is also a complicated set of special QPRT/grantor trust valuation rules for estate and gift tax purposes, which are outlined in Internal Revenue Code §2702 and related regulations. 

As with most estate planning strategies, you should consult with an attorney who specializes in this type of law to determine if a QPRT is right for your situation. An estate planning lawyer who knows their stuff can help you decide on the best methods for saving your money from the IRS, determine if you can qualify for a QPRT and make sure it’s set up correctly if you choose to take that path. 

 

Filing for Incorporation: What To Know About Making Your Business Legit

Most serious real estate investors eventually consider filing for incorporation to make their business legit. While the process can be complicated, it’s well worth the effort to protect your assets through incorporation.

Before we dive into the nitty-gritty of starting a corporation, it’s important to keep in mind that incorporation is only one option for making your business "official" in the eyes of Uncle Sam and the IRS. Depending on the circumstances, you might find that it’s preferable to form an LLC or Series LLC to protect your assets.

I recommend consulting with my team or another attorney specializing in real estate investing to make sure you choose the most advantageous option for your situation. Check out our article on Series LLC Rules to find out more on that front.

What Does It Mean To Incorporate Your Company?

When you incorporate your business, you form a corporation, which is a legal entity that is separate from its owner. Corporations are taxed independently from their owners and can be held legally liable for corporate actions. A corporation’s profit is separate and distinct from its owners’ income.

Corporations are created by state statute, which means that each state has its own requirements and regulations by which corporations must abide.

The owners of corporations are usually referred to as “shareholders,” and there is no maximum number of shareholders that a corporation can have. In most states, shareholders can be individuals, LLCs, other corporations, and foreign entities. Most states also permit an individual to form a single-shareholder corporation.

How Much Does It Cost To Start A Corporation?

To start a corporation, you will usually have to cover four different types of costs. These fees include a filing fee paid to the Secretary of State, a first-year franchise tax prepayment, governmental filings fees, and attorney fees.

Depending on the state of incorporation, Secretary of State filing fees can be a flat fee, determined by the number of shares authorized or a combination of both. Secretary of State offices typically charge between $100 to $250 for filing fees.

Franchise taxes are required by some states to be paid for the privilege of doing business as a corporation in that state. Franchise fees usually range from $800 to $1,000, but some states do not require this tax to be paid.

What Documents Are Needed For Incorporation?

To incorporate your business, you’ll need to file a few different types of documents.

Articles of Incorporation

Articles of incorporation are the legal document that creates a new corporation. To start your corporation, you’ll need to file articles of incorporation with the appropriate entity in your state. In many states, you’ll file with the Secretary of State, but this can vary.

The required information for your articles of incorporation to include can differ between states, but most states require at least the following info:

Every state will charge a filing fee, which generally ranges from $100 to $500. Once the state entity processes the articles of incorporation, they will send you a certified copy that confirms that your corporation has been approved to do business in the state.

Articles of incorporation are only required if you are forming a corporation. If you decide to go with an LLC, you’ll need to file a similar document called articles of organization.

Corporate Bylaws

Corporations must also establish corporate bylaws, which determine how the company’s shareholders, officers, and directors will divide authority and management in the business. The bylaws will also outline how the day-to-day functioning of the corporation will operate.

People often confuse articles of incorporation and bylaws, but they serve entirely different functions. While the articles of incorporation establish the corporation’s foundation, bylaws are much more detailed and explain how the corporation will be run.

Tax Election Form

For many businesses, it may be advantageous to be taxed as an S-Corporation instead of a C-Corporation, as income from a C-Corp is taxed twice. Because corporations are separate taxable entities, your business will have to pay taxes on its profits, and then you’ll have to pay personal income taxes on the money you make from your business.

An S-Corporation, on the other hand, is what is known as a “pass-through” entity. Because S-Corps don’t have to pay their own taxes, all of your business profits are passed through to your personal income.

The default tax election for all new corporations is a C-Corp. This means if you do nothing, you’ll be taxed as a C-Corp. In order to be taxed like an S-Corp, you will need to file Form 2553, Election by a Small Business Corporation, with the IRS.

Can I Incorporate Without A Lawyer?

While it is possible to incorporate without a lawyer, it is not recommended. An experienced attorney can guide you through the decision-making process and ensure you pick the legal structure that best suits your business. A lawyer can also help you hide ownership of a company to maintain your anonymity.

You don't have to call us to get this done—but please call someone who knows the law.

Section 179 Property Tips: How to Scoop Up Big Write-Offs

I work with savvy real estate investors day in, day out to give them strategies to protect their hard-earned moolah from Uncle Sam’s clutches.

One tactic many of them overlook is the Section 179 property deduction. With this write-off, you can deduct the total value of certain types of property instead of having to depreciate it over time.

Here's a rundown of how it works.

What Is Section 179?

Section 179 of the United States Internal Revenue Code (26 U.S.C. § 179) allows investors to deduct the cost of certain types of property in the year it is purchased and put into use.

Under the typical deduction process for property purchased as a business expense, tax law would require the cost of the property to be capitalized and depreciated over time. But with Section 179, you can write off the total cost of eligible property instead of having to wait for the property to depreciate.

While Section 179 write-offs can be used for various types of business structures, it is particularly advantageous when you combine it with the tax savings offered by an S Corp. With an S Corp Section 179, you get the benefits of pass-through taxation combined with tax deductions for your business expenses.

What Property Qualifies For A Section 179 Deduction?

Unfortunately, you can’t deduct all the property you obtain for your business using Section 179: only certain assets can be written off. To qualify for a Section 179, the business property must meet the following criteria:

It Must Be Tangible

To be eligible for a Section 179 deduction, an asset must be tangible personal property. In most cases, it will be equipment or office furniture, but other types of property can be deducted.

It Must Have Been Purchased, Not Leased

A Section 179 write-off can only be used only property that you purchase using business funds during the tax year, including loaned funds. You cannot deduct leased property, inherited property, or gifted property using Section 179. Financed property may be deducted, however, as you'll see in a bit.

The Property Must Be (Mostly) Used Specifically For Your Business

You can only deduct property under Section 179 if you use it for business purposes more than 50% of the time. If less than 50% of the use is for business purposes, you cannot use Section 179, which means you’ll have to depreciate the asset instead.

If less than half of the use of the property is for personal purposes, you can still deduct the purchase using Section 179. However, you’ll need to reduce the amount of your deduction by the percent of the time you use it for personal purposes and keep records of your business use of the property.

The Property Must Be Used During The Current Tax Year

You can only use a Section 179 deduction for property that was purchased, acquired, or converted to business use in the current tax year.

The Property Must Be Acquired From A Non-Related Party

You cannot use a Section 179 deduction for property purchased from a relative or another corporation or organization that you control.

What Property Does Not Qualify As A Section 179 Write Off?

The following types of property cannot be deducted under Section 179:

Limitations on Section 179 Deductions

There are also several limitations in place that restrict the amount of Section 179 deductions you can take in a single year:

Section 179 And Equipment Financing

Did you know that Section 179 also works with equipment financing? Many people don’t realize they can also use Section 179 to deduct the entire cost of financed equipment, thinking they can only write off the amount they actually paid. Fortunately, this isn’t the case! If you finance an equipment purchase with a loan, you can still deduct the total purchase price. And as an added bonus, you can also include the borrowing costs in your Section 179 write-off.

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 Is Passthrough LLC Income for Tax Purposes?

There are two short answers to the title question: yes, and hell yes.

But don't just take our word for it. Passthrough LLC income is a hot topic in the investment community. If you're not sure what that means, you're not alone. Read on to learn about what exactly passthrough income is, how it impacts your LLC, and what benefits you will reap from it.

What is 'Passthrough' Income?

Passthrough LLCs allow you to collect the profits from your business as part of your personal income tax. The LLC itself is not taxed, but its owners are. This allows you to save substantially, simplify filing, and enjoy more of your hard-earned profits.

Businesses love this feature so much that at the time of this writing, roughly 90% of entities take advantage of passthrough income. While this access used to be primarily the domain of giant corporations, even the smallest business can also take advantage.

How Does a Passthrough LLC Benefit Me?

The most obvious benefit of passthrough entities is that it saves you tremendously on taxes. Opting out of passthrough benefits would mean you would essentially have to pay taxes on your income twice--both on your personal and your business tax returns. Few among us have the means or desire to pay the taxman twice. Fortunately, businesses don't have to if they take advantage of passthrough taxation. This is available for any type of LLC, including our personal favorite, the Series LLC.

What About the Taxman?

While passthrough has always had the benefits discussed above, there are even more perks you can take advantage of when Tax Season rolls around. Below are some of our favorite perks, along with a little update about the 2018 Tax Bill.

Can I Get Passthrough Treatment for Other Entities?

You bet! S-Corps, Limited Partnerships, and many other types of entities are eligible for passthrough taxation. Of course, we recommend the Series LLC for real estate investors. All of the information above applies to the Series LLC the same as it would to its Traditional counterpart.

That's all for our discussion of passthrough income for LLCs and Series LLCs. That wasn't too painful now, was it? You learned the basics in under ten minutes, but please feel free to reach out for personalized recommendations by taking our Tax Discovery Quiz below.

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

How to Get an Employer Identification Number (EIN) for a Foreign Entity

If you’re interested in any of the following, you’ll need an an Employer Identification Number (EIN), also known as a Federal Tax Identification Number:

The Internal Revenue Service issues IENs for corporations and partnerships to properly track their business activities for taxation and general monitoring. Here’s a full list of different types of businesses that are required to have an employer identification number.

Even if you’re a sole proprietorship, you still might want to get an EIN to protect your identity. You don’t want to go around handing out your social security number all the time, after all.

But what if you aren’t based in the US? Can you still get an EIN? If so, how do you get an EIN for a foreign entity?

Let's start with a basic question:

ein foreign entity

What is a foreign entity?

Before your business can operate in a state other than your home state, your corporation, LLC or other entity must qualify to “transact business” in that state, and is considered a foreign entity.

In general terms, any business entity not incorporated in your home state is considered a “foreign entity." A Series LLC in California is a "foreign entity" in Texas. For the purposes of this article, however, we're talking about an actual overseas business entity—not a business based in another state.

Previously established out-of-state businesses have typically already registered for an EIN from the IRS, so that California SLLC won't need a new EIN to transact business in Texas.

How to Apply for an EIN for a Foreign Entity

Quick and easy answer: review the information below, fill out the SS-4, and then call the international EIN helpline for the IRS at 267-941-1099 (which is not toll free).

To get an EIN as a foreign entity, you need to fill out Form SS-4, aptly titled, “Application for Employer Identification Number.” (The IRS’s internet EIN application is their “preferred method” for applying for most entities looking for an EIN, so if you stumbled upon this page and you’re not a foreign entity, start there). With that said, however, for international applicants, the IRS recommends calling the following non-toll-free number: 267-941-1099.

To do so, you’ll need the following information, at a minimum:

If you’re filling out the form online, make sure to follow the instructions very carefully to make sure the process is as smooth as possible.

Tips to Make Sure Your EIN is Approved

You’re only eligible to apply for an EIN online if you meet certain criteria:

If you don’t meet those criteria, call the number at 267-941-1099.

Why Do You Want to Apply for An EIN Even If You Don’t Have To?

Why might you want to apply for an EIN even if you’re, let’s say, a sole proprietorship?

There are a few reasons, and we touched on some of them in the intro, but we’d like to go over them for good measure here—as well as add some more:

An EIN allows you to file business taxes and avoid tax penalties.

There are certain tax breaks that are only available for businesses. Take, for example, the PPP loans as part of the pandemic. Many of them were even forgiven, so they were essentially grants for certain businesses.

An EIN can protect your Social Security Number.

Occasionally you might have to fill out forms for your business. If you have an EIN, you no longer have to use your more sensitive personal information to fill out those forms.

An EIN opens up a variety of business accounting options.

With a foreign EIN, business loans and business savings accounts are options for you to consider.

An EIN speeds up pretty much everything related to running a business.

With an EIN, you can more easily do everything you need to run a business, and if you’re a foreign entrepreneur, it lends you that much more credibility to US businesses and workers.

The Takeaway

A foreign entity EIN can have benefits, as we've seen. In order to get an Employer Identification Number for a Foreign Entity, you should look over Form SS-4 from the IRS, prepare all of the information you’ll need, and then call 267-941-1099. If you fill out the application online, your business needs to be located in the US or any US territories.

Which Type of Business Entity Needs an Employer Identification Number (EIN)?

Businesses pay taxes. It is a truth as old as time. However, how a business entity pays taxes vary. For many, the Internal Revenue Service (IRS) requires them to file for an employer identification number (EIN).

The EIN, also referred to as a taxpayer identification number (TIN), is a unique number assigned by the IRS that allows it to monitor any payments, wages, or other financial transactions that occur through your daily business activities.

Furthermore, if you plan to open a business bank account, an EIN will help you establish one that is independent of your own personal account. 

Does a general partnership need an EIN? What about an LLC taxed as a corporation? To find whether or not your business entity requires an EIN, keep reading.

does a general partnership need an ein Business Entities that Do Require an EIN

Business Entities that Do Not Require an EIN

Business Taxes

The nuances of the tax world can be confusing and hard to understand. If you run a business and would like to discuss taxes with a professional, call Royal Legal Solutions today to set up a consultation. Our professionals have years of experience helping clients make the most of their business while remaining in compliance with all laws and regulations.

 

Interested in learning more? Read How to Get an Employer Identification Number (EIN) for a Foreign Entity and When Does a Sole Proprietor Need an EIN?

2021 Is A Critical Year for Estate Planning—A Trust Is A Great Start

Real estate investors were thrown a few curveballs last year, to say the least.

The stress and uncertainty of 2020 motivated a lot of you to stop procrastinating and get your financial affairs in order. Trust me ... Financial planners and asset protection attorneys have been working overtime.

On top of an unprecedented global pandemic, another election cycle brought the prospect of legislation that could change how our businesses (and our estates) are taxed.

With the current estate credit set to end in 2025, proactive business owners were calling us before COVID spread throughout the globe. But the events of 2020 have even more of you thinking about the gloomy prospects for recession, disability or death.

Whatever happens with the pandemic and the fallout for landlords, 2021 is shaping up as a critical year for estate planning because of President Joe Biden's proposal to lower estate tax exemptions. Biden proposals include limits to the gift, estate, and GST exemption amounts a taxpayer can take. According to The National Law Review, it is now more important than ever to create an estate plan or review the terms of an existing one.

Worried yet?

Don't be. As with many things in life, a little preparation goes a long way. You have a lot of options.

For example: Setting up a trust, which allows a third party—or trustee—to hold assets on behalf of your beneficiaries, can offer you valuable peace of mind. With a trust in place, your heirs will not have to go through the time and expense of probate. A trust also allows you to protect your assets, maintain privacy, and reduce estate and gift taxes.

Even if you have an estate plan in place, it is critical to update it each year to allow for life’s many changes, including births, deaths, weddings, divorces, illnesses, and children reaching the age of majority.

In this article, we'll examine one of the primary components of estate planning—selecting who will serve as your personal trustee. But first, let's look at the changes that 2021 could be bringing to the way estate planning attorneys like me handle our clients' affairs.

estate planning: biden changesWhat Estate Law Changes Will 2021 Bring?

Changes that impact the way we leave assets to our families are afoot.  These include:

The world is changing. Your family and your needs are changing. Estate plans should be updated every year to reflect these shifts, to give you peace of mind and preserve your wealth for your loved ones.

Creating a Trust Is A Great Start

Updating your estate plan for 2021 means finding ways to control where your assets will go should you die or become otherwise incapacitated. Establishing a land trust or another kind of trust can do exactly that.

Determining who will serve as your trustee is a key step. This individual acts as a fiduciary, overseeing the management of property owned by the trust. The person (or persons) you choose must have a clear understanding of the role. The primary expectations of a personal trustee include:

While those duties align with moral responsibilities, the position also comes with distinct hands-on tasks such as paying bills, reporting taxes, fulfilling obligations to beneficiaries, and following all compliance requirements. Making investments may also be part of the job.

Particularly with large estates, the trustee may be exposed to legal action by the beneficiaries of the trust. As you can see, the position or the offer of the position should not be taken lightly. You'll want to make sure the person fully understands the responsibilities and isn't blindsided with them after your death.

In addition to being a trusted friend or family member, a trustee can be a professional (such as your attorney) or an institution (like a bank). You also can to have an individual and an institution serve as co-trustees. A professional trustee can help shift the legal liability of the position away from the personal trustee while keeping them informed and part of critical decision-making.

How is a trustee compensated for their time?

Choosing who will serve as your personal trustee is an important decision. It should be someone who knows you well and who gets along with your family members. It's more than an honor; it's a serious commitment to you and your heirs.

Both personal and professional trustees are entitled to payment for their work. As you might expect, the compensation depends on the size of the estate and the amount of work the position requires.

There is no set fee for a trustee, and most trust documents and state laws state that trustees should earn a "reasonable" amount for the work. What is a reasonable amount? Here are some guidelines:

In some cases, a trustee may not want to receive financial compensation for their work. One consideration is that a trustee's remuneration is taxable as income. But family relationships also can enter into the picture.

For example, a relative may choose to forego payment for their time as a trustee because they view the position as a family responsibility. Others may think that accepting payment could cause friction or strain within the family.

curve ballThe Takeaway

With the rate of COVID vaccination increasing, many of us are looking forward to returning to some semblance of normal life in 2021. However, we would be wise not to ignore the wake-up call that the pandemic has given us to get our affairs in order. And thanks to legislative changes, investors are faced with a whole new ball game going forward. 

None of us knows what the future holds. No matter the size of your estate, you'll gain valuable peace of mind when you create or update your estate plan in 2021.