Calculating the New Pass-Through Deduction for Real Estate Investors

The Pass-Through Deduction, introduced by the Tax Cuts & Jobs Act, allows sole proprietors, partnerships, and S-Corporations to deduct up to 20% of their qualified business income (QBI).

Since many real estate investors operate under one of these entities mentioned, how will this impact you?

Investors with Taxable Income Below $157,500 ($315,000 if married)

If you operate under one of the entities mentioned above, and have taxable income less than $157,500 ($315,000 if married), you will simply be able to deduct 20% of your qualified business income (QBI).

For small landlords that report rentals on Schedule E, this deduction will apply to the aggregate income or loss of your rental activity, and not to each individual property (at least as of this writing). Because rental real estate often creates a loss for tax purposes, this deduction may not apply to everyone.

However, flippers, developers, agents, and larger landlords should see a greater impact from the deduction.

Example: You are a married investor with five rentals that produce net operating income of $90,000. You also have W-2 wages of $160,000, because you are below the $315,000 threshold, you will be able to deduct $18,000 from your net operating income ($90,000 x 20%).

Assuming you are in the 24% tax bracket, you will save $3,600 on your tax bill.

However, if your five rentals produce a net operating loss of $13,700, you are not eligible for this deduction even if one of the five rentals produces net operating income.

Investors with Taxable Income Above $157,500 ($315,000 if married)

If you’re an investor with taxable income above these thresholds ($157,500/$315,000), things get a little more complicated as W-2 wage limitations have to be considered.

Below are the rules to calculate the pass-through deduction if your taxable income is above the phase-out thresholds:

Example: If your QBI is $350,000, your business has $120,000 in W-2 wages, and has qualified business property with an unadjusted basis of $1,200,000, your pass-through deduction will be the lesser of:

Your deduction in this example would be $60,000. Assuming you’re in the 35% tax bracket, you will save $21,000 on your tax bill. 

The Bottom Line on the Pass Through Deduction

The pass through deduction has the potential to shave thousands off your bill if you operate as a sole proprietor or use a pass-through entity such as a partnership. However, small landlords may not see the benefit if their aggregate rental portfolio shows a loss for tax purposes.

Because this deduction is still new and can be complicated to calculate, it is recommended that you work with your CPA to determine how this deduction will impact your specific situation.


Author: Thomas Castelli, CPA is a Tax Strategist and member of The Real Estate CPA, an accounting firm that helps real estate investors keep more of their hard earned dollars in their pockets, and out of the government’s, by using creative tax strategies and planning.

How is A Land Trust Different From A Standard Trust?

A land trust is defined as an entity used to hold title to real estate. Unlike the standard trust, usually land trust doesn’t involve family. Also, a land trust offers versatility for real estate investors since they are allowed to hold not only real estate but real estate related assets such as real estate notes. A land trust can also hold deeds and financial agreements.

Land trusts also provide several benefits:

  1. A land trust doesn’t go through probate court. As personal property, land in a trust doesn’t go through the usual tedious court proceedings required to sell, rent and otherwise manage property in the land trust.
  2. A land trust offers anonymity. This is one of the most attractive facets of a land trust and a critical component in preventing lawsuits. The name recorded on a trust is not attached to the parties involved in the trust, thus any worth or personal information attached to that property is hidden. As a result, lawsuits don’t appear to have much monetary incentive and seem more of a hassle to pursuit.

Revocable and Irrevocable Land Trust

However, there are some important tax considerations to keep in mind. Tax treatment depends on the type of trust that’s established. According to IRS definitions: “The land trust has no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of the trust instrument. Filing requirements would depend on the type of trust.” Here are the two types of trust:

  1. Revocable Trust. Most land trusts are revocable. A revocable trust is one in which the provisions can be either canceled or adjusted.
  2. Irrevocable Trust. An irrevocable trust is where the grantor, or creator of the trust has forfeited his rights of ownership.

Land Trusts as Pass Through Entities

Because most land trusts are revocable, they don’t have to file a separate return. This is because a revocable land trust is seen as a pass through entity by the IRS. Any income on the land trusts is treated as personal income and thus reported only on a personal tax return. As a pass through entity, a land trust doesn’t lead to the grantor being taxed twice. It also saves time and money, since additional tax filing documents and fees aren’t required.

For instance, Jane is recorded as the individual who has the power to revoke the land trust named Oak Tree 123. This may seem like a vague and uninteresting name, but this can actually work to Jane’s advantage. Names that are vague and uninteresting are bad for your Tinder profile, but creative trust names are great for your land trust. When tax time rolls around, Jane will simply report any income from her Oak Tree 123 trust on her own personal income form, reporting it just like it was any other type of income.

Incorporating Your Land Trust with a Series LLC

When you incorporate your land trust within a series LLC, the tax filing process not only remains simple because it’s a pass through entity, but you also enjoy maximum asset protection. Remember, a land trust is just like a regular trust in that it provides anonymity. The anonymity of a trust can help prevent lawsuits from even starting. Meanwhile, the series LLC structure separates assets under individual “child” LLCs, so an attack on one LLC doesn’t spread to others. However, a land trust can be incorporated within a variety of entities such as an LLC or S-Corp. Each will have its own tax implications to consider and cost, especially if you’re managing multiple LLCs.

When a Land Trust Requires a Trust Tax Return

There are a few exceptions to the tax filing procedure mentioned above with Jane’s revocable land trust. In cases where the landowner passes, the beneficiary will be required to file both a tax return on the trust and estate. In addition, in the more uncommon case of a land trust being irrevocable, the usual tax filing procedure mentioned above won’t apply. Instead, the trust creator may have to file a separate trust tax return. This would require filing out tax form 1041.

Steps to Filing Taxes With a Land Trust

Whether you have a revocable or irrevocable land trust, the following steps are essential to staying out of trouble with Uncle Sam.

  1. Keep accurate records of income. This will be reported along with information about gains and losses.
  2. Consult with a legal team. Our team of experts are real estate investors themselves. We can help you setup a land trust that provides maximum asset protection as well as potential tax benefits.
  3. Ensure all tax documents are copied and shared with the main parties of the land trust. These include the beneficiary, grantor, and trustee.

Combine Asset Protection and Tax Efficiency

We hope this article has been useful in explaining some of the important tax considerations to be mindful of when working with a land trust. We are one of the few firms in America to regularly manage land trusts. Our expertise allows us to provide a combination of asset protection and tax efficiency.

Interested in learning more? Check out our article How Honest is it to Use a Land Trust for Asset Protection?

Are Legal Expenses Tax Deductible for Real Estate Investors?

When it comes to legal expenses, what can and cannot be claimed as a tax deduction can be confusing. In fact, the answer really depends on the nature of the legal expense itself. Whether you’ve formed a series Limited Liability Company (LLC) or are using your self-directed 401(k) to make real estate investments, Royal Legal Solutions is here to help.

The Rules

The Internal Revenue Code (IRC) is the governing set of laws created to define what can and cannot be taxed. It is written by our US Congress and approved by the President. The IRC dictates that, with few exceptions, that you cannot deduct personal, living or family expenses on your income tax returns. (Itemized deductions are one of the exceptions.) The IRC does, however, allow the individual to deduct certain ordinary and necessary expenses that are paid throughout the tax year. These include:

Legal Interpretations of These Rules

How the Internal Revenue Service (IRS) views the laws established in the IRC can often seem convoluted. However, case laws have helped to demonstrate the legal interpretation of these rules. While there are other ways in which these rules can be applied, below are a few that are best related to the real estate investor’s interest.

Expert Services

The professionals at Royal Legal Solutions understand how complicated tax laws can be. As part of our expert services, we can help to prepare any tax filings related to your business or investments. If you would like to learn more about how Royal Legal Solutions can help, take our Tax Discovery Quiz.

Keep more of your money with a Royal Tax Review

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Unpaid Debt Can Take Your Tax Refund as a Real Estate Investor

At Royal Legal Solutions, taxes are always on our minds. We know what you are thinking. Tax season is months away! However, now is the time to start paying down any unpaid debt you may have. Why? Because certain types of debt will garnish your tax refund check before you even lay your hands on it.

How is this possible?

The Bureau of the Fiscal Service (BFS) is the Treasury Department branch that issues your federal tax refund checks. However, through the Treasury Offset Program (TOP), Congress has authorized the BFS to reduce your refund check in certain cases. In fact, the BFS can reduce or even take all of your refund and apply it to your unpaid debt.

Types of Unpaid Debt

Not all debt will result in the reduction of your tax refund. If you own on your mortgage, for example, your tax refund will not be affected. However, debt related to the below categories can result in a reduction.

What Happens

Being proactive now can help decrease the amount of debt owed, which can then prevent or reduce the likelihood of losing your tax refund. First, you should contact the BFS TOP call center. You can contact them at 800-304-3107 or TDD 866-297-0517 to inquire about whether your debt falls into any of the categories above.

If you fail to pay any debt that will be subjected to TOP, the BFS will likely reduce or take all of your tax refund in order to pay off the amount owed. If there is a balance after TOP garnishes your owed debt amount, the remainder will be issued to you as a check or through direct-deposit.

Furthermore, if the BFS reduces your tax refund, you will receive a notice with the amount and the agency that filed the claim. You can contest this amount by contacting the agency that filed for the offset.

What if Spouses Files Together?

If you file a joint tax return with your spouse, but they are solely responsible for debt, you may still be entitled to part or all of your refund. To do this, you will need to file Form 8379, also known as the Injured Spouse Allocation.

Speak With a Professional Today

If you are worried about the upcoming tax season, you should contact a professional today. For those who invest in real estate, which provides plenty of financial growth potential, figuring out your tax standing now can help you avoid losing your tax returns. At Royal Legal Solutions, our professionals are here to ensure you get the most you possibly can out of a tax return. Not only can we help save your taxes, our experts are able to better help you protect your assets. To find out more, please take our tax quiz to schedule a consultation with us today!

Are Charity Auction Purchases Deductible Contributions for Real Estate Investors?

Charities often hold auctions as a way to gain valuable contributions that help better their cause. If you are a real estate investor, you may wonder whether your auction purchase at one of these charity events can be considered a deductible contribution. Below, Royal Legal Solutions helps clarify how charity donations work on your tax returns.

Charity Auction Purchases

According to the Internal Revenue Service (IRS), some, but likely not all, of the money you paid for an item at a charity auction is considered deductible.

As stated above, the IRS only considers a portion of your auction purchase to be a deductible contribution. Some charities will provide a catalog of items prior to the start of the auction. In this book, you may find a “good faith” estimate on each item’s estimated worth. Assuming you have no reason to doubt the validity of these estimates, this catalogue is an important piece of evidence. Why? The IRS will only consider the portion of your purchase that goes above “fair market value”. However, you need to demonstrate that you knew the value before you paid for the object. Having a catalogue that provides this is a quick and easy way to prove this.

If a property is listed for auction, a proactive sale will include the estimated fair market value. This will include an examination of how developed the property is, as well as its current state. Purchasing this property for $10,000 more than the estimated fair market value means you could potentially claim that additional money as a deductible contribution to a charity.

Providing Assets to a Charity

Another question we often get is regarding charitable donations. Unfortunately, the IRS limits the amount you can claim as a deduction. Unlike purchasing an item, you cannot claim fair market value for items you donate. Instead, you can only claim an amount relative to your tax basis.

When In Doubt, Ask a Professional

At Royal Legal Solutions, we can help you address any tax questions you may have. As a real estate investor, retirement plan owner, or business entity – our professionals understand how the tax laws affect your returns. If you have questions regarding charity contributions, whether through purchase or donation, the experts at Royal Legal Solutions can help you get the most out of your tax filing. If you would like to schedule a consultation with one of our professionals, contact us today!

Getting The Most Out of Employee Business Deductions

As an individual taxpayer, the Internal Revenue Service (IRS) allows you to make certain deductions. For example, you can make miscellaneous itemized deductions in relation to expenses incurred during your employment.

For the most part, taxpayers should only claim these deductions if they were not reimbursed by their employer for these expenses. Additionally, these expenses must be considered ordinary and necessary in order for you to do your job. They cannot include personal expenses.

Deduction Barriers

While the IRS does allow for you to deduct these items, they also have established two barriers that reduce your overall deduction value.

The first barrier, also known as the 2%-of-income, or AGI, tax is the most likely to affect Tier II miscellaneous deductions. (Tier II miscellaneous deductions include, but are not limited to, those related to employee business, investment, some legal and home office expenses.) The 2% AGI barrier totals up all of the miscellaneous deductions and reduces the value by 2% of the taxpayer’s AGI for that year.

The second barrier, AMT, will make all Tier II expenses non-deductible. However, Royal Legal Solutions can help you plan your deductible approach this tax year. Below, we list several strategies that can help you get the most out of your deductions.

Employee Business Deductions Strategies

Overcoming the IRS barriers is easier if you have a set strategy. Let’s take a look.

 

Preventing Tax Problems When Partners Travel

As a business entity, tax laws can be rather confusing. While some of the tax codes, as established by the Internal Revenue Service (IRS), are straight forward, others can be complex. The professionals at Royal Legal Solutions understand how stressful filing taxes can be. We are here to help. When it comes to partner and employee travel, below are a few things that can help you get the most out of your business travel expenses.

Rules to Know

As an employer, the IRS has several rules you should know. However, we will focus on two of the most significant ones.

Following the Rules Earns You More

When you follow the rules dictated by the IRS, the cost of travel is almost entirely deductible. Meals, for example, are only 50% deductible. The tax-free reimbursement paid to your employee or partner is also not tax deductible. (However, the reimbursement is also not subjected to payroll withholdings or FICA.) If you do not follow the rules, however, everything is still deductible by you as the employer. The reimbursement, though, will need to be added on the employee’s taxable wages instead. This will cause the reimbursement to be subjected to both payroll withholdings and FICA. (The working condition fringe benefit rules dictate that items that are deducted from the employers taxes are not to be included as part of the employee’s salary.)

How It Works

As the employer, you are able to deduct business expenses that are considered to be ordinary and necessary. This includes job-related travel and lodging expenses. (Although, you should note, these accommodations cannot be extravagant or lavish!) An “accountable plan”, which requires the employee or partner to provide justification and adequate proof of all expenses during a job-related travel event, allows an employer to properly deduct these expenses. This means receipts must be supplied to the employer.

When You Don’t Follow the Rules

Everyone loses when you do not follow the rules. When reimbursements are made from the employer to the employee without an accountable plan, they are taxable. To deduct these items, 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 will be subjected to a 2% AGI nondeductible threshold. As a result, some or all of the expense will not be able to be deducted by the employee. If the employee needs to file deductions for lodging and meals, they must be required by their job to be away from home for at least one night per the away-from-home rule. However, this is only true if the stay is for less than one year. Anything over than that will likely be unable to be deducted.

Royal Legal Solutions and You

At Royal Legal Solutions, our professionals can help you understand the IRS process as it relates to your business. We can help ensure you get the most out of your taxes. If you would like to schedule a consultation, please contact us today!

Which Self-Directed IRA Transactions Trigger the UBTI Tax?

Designating funds for your retirement is a great step if you are planning for your future. You probably already know about the 401(k) and the individual retirement account (IRA). These plans allow owners to invest in various stocks, bonds and mutual funds.

But for those of us who want a little more, there's another option: a self-directed IRA (SDIRA). These plans, which can be traditional or Roth accounts, allow for much more diversified investments. In fact, you can invest is almost anything, including real estate, precious metals, renewable energy and private placements.

SDIRAs and UBTI Tax

Establishing a limited liability company (LLC) in the name of your SDIRA makes a lot of sense. It helps to isolate and protect your investment funds. It also provides you with a level of anonymity that many owners find beneficial.

IRAs and SDIRAs are typically exempt from the Unrelated Business Taxable Income (UBTI) tax. This rule, as established by the Internal Revenue Service (IRS) in 1950, was introduced as a means of preventing tax-exempt businesses from unfair competition related to their profits.

Most passive investments made with your SDIRA LLC are considered tax exempt. However, real estate in particular can trigger the UBTI tax. Why? UBTI taxes are generally applied to incomes generated by “any unrelated trade or business” that is “regularly carried on” by an organization that would be subjected to the tax. To better understand this, let us take a look at the main components of this regulation.

What Does 'Trade or Business' Mean In Relation to UBTI?

The Internal Revenue Code (IRC) Section 162 defines “trade or business” as profit-oriented activities that involve regular actions by a taxpayer. There are very few cases in which activity needs to be attributed to a trade of business, however. This is because most expenses that are incurred from the profit-oriented activities of a taxpayer can be listed as deductibles under IRC 212.

What Does 'Regularly Carried On' Mean In Relation to UBTI?

For an activity to be considered “regularly carried on”, it is compared to those activities of a competitive, taxable business. There are some nuances to this. A short-term activity are typically tax-exempt if a similar commercial occurs all year. An example of this would be an ice cream stand operated by a tax-exempt organization during a state fair. Seasonal activities, however, are likely to be subjected to the UBTI tax. Intermittent activities are typically exempt if they are done so without the same type of promotional actions taken by a commercial enterprise.

UBTI Tax Triggers

It is important to identify and quantify the types of activities your SDIRA LLC has used to generate profits. This will help you to determine whether the activity and its profits are exempt or not. As previously stated, most passive transactions associated with your SDIRA LLC would not be subjected to the UBTI tax. However, there are several that could.

Legal Examples

There are plenty of examples of taxpayers butting heads with the IRS. Let us take a look at two examples that resulted in very different court rulings.

Invest with a Professional

Finding the right plan can be hard. However, when you open an account with a reputable professional, like IRA Business Trust, our experts go to work for you. Not only do we handle any documents and tax forms you may need, but also as experts, we understand where the IRS draws a line. Your SDIRA is a vital part of your future. To find out more about opening a SDIRA, forming an LLC, or understanding UBTI, contact us today!

The Self-Directed IRA Plan Asset Rules

When you open an individual retirement account (IRA), you do so as a way of saving for your golden years. An IRA allows you to invest in mutual funds, stocks and bonds. However, a self-directed IRA, also known as a SDIRA, permits much more.

With your SDIRA, you can invest in real estate, private placements, precious metals and more. In fact, with a SDIRA, you can invest in almost anything. However, there are some rules. The Department of Labor (DOL) established the Plan Asset Rules as a way to define what is considered an IRA asset. By understanding this rule, you can avoid participating in a prohibited transaction.

Plan Asset Rules

The Plan Asset Rules are also referred to as “Look-Through” Rules. Two main things can trigger the Plan Asset Rules. These are:

Exceptions to the Plan Asset Rules

There are certain exceptions to the DOL Plan Asset Rules. We noted the rules as they apply to an operating company—a partnership or limited liability company (LLC) that typically engages in the development of real estate as well as venture capital or companies that provide various goods and services. When it comes to an operating company, if the plan does not own 100% of the partnership or LLC, then the DOL rules do not apply.

However, you should still review and understand prohibited transactions as defined by the IRS. These transactions can cause the IRS to treat your actions as an early distribution. This will result in penalties! The Plan Asset Rules will also not apply if the operating company, or the interests of the partnership or membership, are publicly offered. The same is true if the interests are registered under the Investment Company Act of 1940.

Impact and Consequences

In reality, many of your investments will not trigger the DOL’s Plan Asset Rules. Direct purchases of real estate, precious metals and many other types of transactions performed on behalf of your plan will not trip the Plan Asset Rules. In fact, even if it otherwise would, as long as a disqualified person does not participate in the transaction, you will not trigger these rules.

Violating the DOL’s Plan Asset Rules does come with consequences. However, when you establish a SDIRA with a reputable law firm, avoiding these consequences is easy.

Is My Airbnb Subject to The Self-Employment Tax?

Typically, rental real estate is a passive activity, reported on Schedule E, and is not subject to the self-employment tax (currently 15.3%). However, as we will learn with Airbnb properties, that is not always the case.

When is an Airbnb REI Property Not Subject to the Self-Employment Tax?

For starters, if you are renting part of your home as an Airbnb for 14 days or less, you do not have to report or pay taxes on that income at all. Nice right? Of course, you cannot deduct related expenses either.
The duration of the average stay at your Airbnb also does not cause you to be subject to the self-employment tax.

However, when your average stay is less than 7 days, it is considered a business and not a rental activity, and is reported on Schedule C. Normally, income reported on Schedule C is subject to the self-employment tax, but that’s not always the case for rental properties.

As long as you are simply renting out your Airbnb and providing no additional services, you will avoid the 15.3% self-employment tax, even if it is reported on Schedule C.

When Is an Airbnb Investment Property Subject to the Self-Employment Tax?

For a rental property to be subject to the self-employment tax, you would provide substantial (beyond regular rental real estate services) to long-term tenants.

These services can include:

This is because you are now providing a more hotel-like service, which is considered a business and subject to the self-employment tax.

So if you are renting out a property using Airbnb or a similar service, and want to completely avoid the self-employment tax, then it is important not to provide substantial services to your guests.

A Few Tips on Mitigating the Self-Employment Tax on Airbnb Rental Properties

So what if you do provide substantial services to your guests, now what?

Well, there are a handful of things that can help you mitigate the self-employment tax. The first is making sure you are properly tracking and deducting all your rental expenses, including depreciation. As we know this “phantom expense” can cause a property to show a loss for tax purposes, or at the very least significantly reduce the net income.

The next is putting your Airbnb properties in an S-Corp, or an LLC taxed as an S-Corp. By doing this you can split your income between W-2 wages, which are subject to the self-employment tax, and distributions which are not.

While not really a tip, but something to keep in mind, if you’re already earning $118,500 or more before your Airbnb income, you will only pay the 2.9% Medicare portion of the tax because the Social Security portion of the tax is capped on $118,500 $137,700 (updated for 2020) of income.

The Bottom Line On Self-Employment Tax on Airbnb Rentals

As long as you are not providing substantial services to your guests, you shouldn’t have to worry about the self-employment tax on your Airbnb.

However you will want to work with a tax professional who understands how to properly report these properties come tax time.

Be sure and check out our article, Tax Consequences For Section 280A and Airbnb Vacation Rental Assets.


Author: Thomas Castelli, CPA is a Tax Strategist and member of The Real Estate CPA, an accounting firm that helps real estate investors keep more of their hard earned dollars in their pockets, and out of the government's, by using creative tax strategies and planning.

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 Full-Time Real Estate Investors Save Thousands in Taxes by Electing to be Treated as a Real Estate Professional

The tax code can be a wonderful thing for real estate investors, especially for those who invest full-time. This is because there is a special rule that can save taxpayers, active in a real estate trade or business, thousands of dollars in taxes.

Why is The Real Estate Professional Status so Important?

As you may already know, rental real estate often creates a loss for tax purposes due to depreciation. And while most investors are limited in the amount of passive losses they can deduct from their ordinary income, real estate professionals can deduct passive losses against their ordinary income without limits.
If you are not a real estate professional, you can deduct up to $25,000 of passive losses against your ordinary income if your AGI is $100,000 or less. This phases out $1 for every $2 of earnings until your AGI hits $150,000, then the deduction is completely eliminated.

Example:

If you made $95,000 in active income (i.e. your job) and had $50,000 in passive losses from real estate you could reduce your taxable income from $95,000 to $70,000, and assuming you’re in the 24% tax bracket, that’s $6,000 in tax savings.
The remaining $25,000 would be suspended until it can be used in future years, and if your income was $150,000+, you would receive no deduction.
However, if you are considered a real estate professional, you could deduct the entire $50,000, saving another $6,000 in taxes.

Who is Considered a Real Estate Professional?

Being a real estate broker, agent, or simply working in a real estate trade or business does not make you a real estate professional for tax purposes.
A real estate professional, for tax purposes, is a person who works at least 750 hours, and more than half their annual working hours in that real estate trade or business. For this reason most individuals with full-time jobs do not qualify for this status.
However, employees who work in a real estate trade or business can use their working hours towards this requirement if they own at least 5% of the company.
For the losses from real estate activities to be deductible against ordinary income, the real estate professional must materially participate in each activity. Therefore limited partnership interests may be excluded.
Married couples can elect this status, if one spouse can meet these requirements. This typically works well when one spouse cannot elect this status being they work a full-time job, and the other doesn’t

Example:

You are a full-time real estate investor and spend 1,000 per year on your real estate business, and you are also a part-time blogger and spend 250 hours in your web business.
Because you spend over 750 hours, and more than half their annual working hours in that real estate trade or business you can elect to be taxed as real estate professional.

The Bottom Line

Qualifying as a real estate professional can save you thousands of dollars in taxes if you invest in rental real estate. However, due to the complexities in qualifying, you will want to consult a tax professional before planning to use, or electing this status.


Author: Thomas Castelli, CPA is a Tax Strategist and member of The Real Estate CPA, an accounting firm that helps real estate investors keep more of their hard earned dollars in their pockets, and out of the government's, by using creative tax strategies and planning.

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

Land Trust Beneficiary: What Does IRS IRC Section 121 Advise?

A land trust is a great way to own property while maintaining your anonymity. With a land trust, the ownership of the property is publicly listed under the name of the trust itself. A land trust has a designated trustee as well as at least one beneficiary.

With most land trusts, the property owner is the beneficiary. This allows them to maintain full control over the property. However, limited liability companies (LLCs), corporations, the trustee, and other trusts can also be listed as the beneficiary. In listing one of these other types of parties as the beneficiary, you increase your anonymity.

To determine whom you should have listed as the beneficiary, you might want to consider the tax implications.

IRC Section 121

The Internal Revenue Service (IRS) establishes regulations regarding taxes. These regulations, known as the Internal Revenue Code (IRC), apply to almost every financial situation in America. A review of IRC Section 121 makes it ideal for the property owner to list himself or herself as the beneficiary of a land trust. Why? Let us examine the code for a better understanding.

The Issue with Entities

A grantor trust, as defined by IRC 671-679, is considered a qualifying trust that can act as a beneficiary of a land trust. A revocable living trust is a qualifying trust as well. If you make an entity your beneficiary instead, you will likely have an issue qualifying under the IRC Section 121. (However, recent court rulings have begun to show promise relating to LLCs and asset protections.)

Let Royal Legal Solutions Help

At Royal Legal Solutions, we understand the intricacies of tax regulations. Our professionals have experience with all aspects of asset protection. This includes the establishment of trusts, LLCs, and other entities. Our experts are licensed to work throughout the United States as well as in Canada.

If you still have questions about IRC Section 121, feel free to ask in the comments section below. If you need specific advice, set up a consultation with Royal Legal Solutions today. Asset protection is not a do-it-yourself gig.

My name is Scott Smith. In addition to being an attorney, I’m a real estate investor myself. If you’re considering a land trust, let us help you protect your valuable investments with a foolproof asset protection strategy from people who’ve been around and seen it all. Take our financial freedom quiz and schedule a free consultation. We’ll help you make your investments bulletproof.

Series LLC Record Keeping Rules

Everything should be kept on record when doing business. It is always a smart idea to have everything in writing to ensure it is all done right.

The same goes for a series LLC and a regular LLC business. Whether you have a one owner business or multiple owners in your business, you need to keep records. Here are a few different record-keeping rules to remember.

Keep Everything Separate

This means you need to keep records of each LLC within the series. A series LLC is several, individual LLCs. Each one needs to be separated and each one needs to have their own records kept. This is because each LLC in a series is distinct from the other one. The reason for a series LLC structure is to be able to manage different businesses. It keeps the management process straightforward and simple.

One thing you need to always remember about a series LLC business is to keep everything separated when record keeping. You don't want to combine them all into one. The reason is because it can leave you unprotected in the business.

Name a Registered Agent

Naming a registered agent for your series LLC is a requirement in most states. A registered agent is a physical address within the state you are located in. If this is a requirement in your state, failing to do so could leave your series LLC business without protection.

Make Sure to be Licensed to Run a Series LLC Business

Many states require business owners to have a license to run properties if they are owned by other people too or if you are managing a property management company. Not only can not being licensed to run a series LLC business put your business at risk, but you can run the risk of a lawsuit too.

Have Separate Bank Accounts

This should be something that everyone already knows since a series LLC is several, individual LLC businesses. Since you are already keeping the records separate for each cell in a series LLC, you should probably also have a separate bank account for each individual LLC in the series. By doing this, you will ensure you are being as careful as possible with everything in each LLC that is under a series.

Make sure you understand each of these series LLC record keeping rules for your series LLC. Also, make sure to abide by all of them and other rules there may be beside these main ones above.

How to Close Down Your Business Yourself

For many small business owners, closing down a business can be a daunting task. This is especially true if your business has incurred a large amount of debt. For most businesses, having some portion of your debts forgiven or filing for bankruptcy are the first thoughts. Bankruptcy is a serious, expensive and time-consuming court option that can significantly affect your credit. For those who opt to liquidate their assets and negotiate their own debt settlements, however, the process can appear overwhelming. Referred to as an out-of-court work out, or work out for short, this option is often cheaper and faster.

Work Out Process Overview

The work out process is actually much easier than you realize. At least the idea of it is. You, or a hired professional working on your behalf, contacts each creditor with a request for them to release you from debt. Often, a percentage of the balance owed is offered to the creditor to help facilitate negotiations. From a creditor’s perspective, filing a lawsuit against you will take time and money. When a fraction of the balance is offered, creditors may be willing to agree or at least enter into negotiations to avoid a court process. This is the most recommended approach for business owners who may be personally liable for business debts, such as sole-proprietors, partner or those who have personally guaranteed a business loan.
 
For corporations and limited liability companies (LLCs), it is likely that you are not personally liable for any business debt. If this is the case, you can close your business, liquidate its assets, and continue to pay creditors until your business funds are exhausted. While you will not need to personally owe on debts associated with these businesses, you will likely be hounded for years by creditors and their representative collection agencies. In the event of a lawsuit, you will need to file a response, which will cost you legal fees.

Advantages

Filing for bankruptcy should be a last resort. Not only will it cost you in court and lawyer fees, but also it will stretch out the timeline as it drags through a lengthy court process. Instead, liquidating assets and negotiating your business debt yourself provides you with more control over your debt. This is particularly important if you are personally liable for any part of your business debt, like:

Disadvantages

Liquidating assets and negotiating settlements can be much more work than you realize. Depending on the amount of money owed and the number of creditors banging on your door, doing it yourself can lead to more trouble than it is worth. Additionally, in some cases, once you enter into negotiations, you will be unable to file for bankruptcy later.

Your Professional Advocate

Hiring a professional, like those at Royal Legal Solutions, can save you time and money. Not only do we understand the negotiation process, we have the experience to get you the best settlement amount possible. Contact us today if you would like to know more about closing a business or debt negotiations.
 

How Traditional LLC Members Are Taxed

Today, we’ll be discussing how LLCs are taxed. One of the most important terms to understand in order to grasp how taxes work with an LLC is “pass through entity.” In these entities, both profits and losses “pass through” the LLC towards each LLC member. Members then report profits and losses on their own personal tax returns.

This is where things can get tricky since we’re dealing with multiple members.

The IRS Uses Distributive Shares to Tax LLCs

Multiple member LLCs are treated as partnerships. Each member pays taxes on his/her own share of the profits and losses. The specific share breakdown is based on the distributive share, which should be outlined in the LLC operating agreement.

Distributive shares are usually based on percentage ownership. Thus, a standard 50/50 split is common. However, there are other arrangements. Let’s look at a common example.

Case Study: Taxing Multi-Member LLCs With Uneven Shares

Kevin and Steve operate a small surfboard shop. According to their LLC operating agreement, the distributive share allocates 70 percent of profits/losses to Kevin and the remaining 30 percent to Steve. This uneven split accounts for the difference in both the time and money both parties can invest in the shop. Come tax time, Kevin and Steve will report their respective shares on their personal income tax return.

No separate business tax filings are required thanks to the LLC being considered a pass-through entity. Both Kevin and Steve can enjoy the liability protection of an LLC, without having to file taxes beyond their own personal tax return. In addition, both parties can report profits and losses according to a distributive share that accurately reflects their economic situation.

Special Allocations in Traditional LLCs

In special circumstances, members may choose what’s called a “special allocation.” This is when LLC members report profits and losses in a way that doesn’t reflect their ownership percentage in the company. With this flexibility, it could be tempting to shift profits and losses in a way that artificially reduces tax liability for certain members. This form of abuse is why the IRS has stringent rules when it comes to meeting LLC special allocation requirements. In fact, special allocations are often rejected.

We can help your LLC meet special allocation requirements and streamline the traditional LLC tax process. Take our Tax Quiz to schedule a consultation.

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How are Sole Proprietors Taxed?

If you’re a sole proprietor and you’re wondering precisely how Uncle Sam takes his cut of your earnings, the answer is simple. You, as the operator of your business, report your income on your personal income tax return. The business itself is not taxed independently of your earnings.

The IRS refers to this as “pass-through” taxation because your profits are passed through the business onto your personal income tax return.

The question then becomes: how do I file and pay taxes on the income I earned through self-employment?

Filing a Tax Return as a Sole Proprietor

Sole proprietors need to report their earnings on Schedule C which is submitted to the IRS alongside Form 1040.

Just like any business, expenses can be deducted. This can include either full or partial expenditures on items you use every day in your business. For instance, if you bought a new computer, but you also use that computer for recreation, part of the cost of that computer can be written off as an expenditure. In other words, you are only expected to pay taxes on your net earnings after expenses, not on your total income.

The 2018 Tax Cuts and Jobs Act also entitles sole proprietors to a pass-through tax deduction of up to 20%, given that certain conditions are met.

The trick for sole proprietors will be to keep their business expenditures separate from their general income. Establishing a separate business checking account can go a long way toward keeping your monies organized. One caveat to that is that if you do want to set up a separate checking account for your business, you may need to apply for EIN as opposed to using your social security number for business-related transactions. Many financial institutions require an EIN, but setting one up is an easy process.

Estimating Taxes

One pitfall to self-employment is when proprietors don’t set aside money to pay their taxes. Then they file and find out that they owe thousands of dollars.

You’ll want to estimate what your quarterly taxes will be based on the previous year. You’ll be expected to pay quarterly as opposed to yearly, and can be penalized for not getting the payment in on time. If this is your first year as a sole proprietor, you won’t have to worry about quarterly payments.

In addition, there is a “self-employment tax”. It’s not really a special tax for those that are self-employed, but it ends up working out that way. When you work a job as an employee, your employer pays half your Medicare and social security. As a sole proprietor, you must pay the full amount. Hence why it’s called a self-employment tax.
This comes to 15.3% of your earned income. However, you’ll also want to bear in mind that there will be taxes you will have to pay to the state you live in as well.

Sole proprietors are poised for excellent earnings with the pass-through deduction, yet there might still be good reason to incorporate for tax purposes. In the end, what makes the most sense for one individual will depend heavily on their amount of earned income.

Can My Husband and I Own Our Business Together as a Sole Proprietorship?

There are some cases where a couple who run a business together wouldn’t be interested in creating a formal business entity.

The question then becomes: can that business, being run by a married couple, be considered a sole proprietorship?

The answer is yes. The IRS allows a lone exemption for married couples who want to structure their business as a sole proprietorship.

Before going into details on that, there are typically four different kinds of business structures that the IRS recognizes. Those include:

  1. Sole proprietorships
  2. Partnerships
  3. Limited Liability Companies
  4. Corporations

In order for the business you run with your spouse to qualify as a sole proprietorship, the following conditions must be met:

  1. There must be no other employees actively engaged with the business. This includes children or other relatives.
  2. Both spouses must materially participate in the running the business.

With those requirements met, each spouse would be required to file their own Schedule C, reporting their individual share (usually an even split) of the business’s income. Each spouse in the husband-and-wife business (sole proprietor or partnership or other) would also need to file a separate self-employment tax form.

Should My Spouse and I Run Our Business as a Sole Proprietorship?

husband and wife business sole proprietor or partnership

This, of course, is a separate issue entirely. The big advantage of a sole proprietorship is that it’s one of the easiest business structures to establish. The major disadvantage of this structure is that you and your spouse are 100% liable if the business fails. Sole proprietorships offer no protection from creditors.

Another option that many married couples employ is a partnership. For tax purposes, it can be easier to file since there is only one form involved. On the other hand, the business will be required to obtain a tax identification number. Partnerships might also be subject to state and federal regulations. The major upside, however, is that partnerships offer more opportunities for growth.

There are no regulations that state that if you start a business as a joint venture LLC, which for tax purposes is considered a sole proprietorship, you cannot later change the structure of the business to a partnership, LLC, or anything else. For many married couples, having the option to start as a sole proprietorship affords them the opportunity to hit the ground running. It’s a simple and effective means of getting their business started without needing to file numerous petitions with state and federal agencies.

What makes sense for your business in the early days, however, may not make sense down the road.

Series LLC Tax Treatment: How the IRS Sees Your Series Entities

The Series LLC comes with so many awesome features for real estate investors that some of us think it's darn-near magical. While it's certainly a powerful structure with plenty of useful applications, even the Series LLC is forced to acknowledge a power greater than itself.

No, we aren't talking about you. We're talking, of course, about the Taxman.

Admittedly, this isn't the sexiest topic in the world, but it's essential knowledge for responsible members of a Series LLC. We'll make this as painless as possible. Below, we'll go over how Uncle Sam views the series within your Series LLC and what you have to do to stay on his good side.

How Uncle Sam Treats the Series LLC

For tax purposes, the Internal Revenue Service treats the Series LLC very similarly to a traditional LLC. The major question I get about this topic is whether each individual series is taxed separately.

For now, the IRS regards the Series LLC as one big entity. This means, that each series within the structure is not considered a separate company and therefore does not require separate returns. Of course, you will have to declare any income you've gained from your Series LLC, and we'll elaborate on that below.

It's important to note that the Series LLC isn't without its tax advantages. Its status as a pass-through entity will save you money and spare you from excessive corporate taxes that you would pay for other types of companies.

How To File Taxes for Your Series LLC

Your operating company (also called the "shell" or "master" company) is what will appear on your tax return. Provided the series that made money for the relevant tax year share common ownership, you can take advantage of pass-through taxation and simply report all income on the Schedule E portion of your personal tax return.

There are ways you could file separate returns for each cell, but this is typically not recommended for Series LLC owners whose income is mostly coming from passive investments like real estate. We do, however, recommend that Series LLC owners keep thorough, separate records for their series to ensure liability protection and simplify the tax process. This applies regardless of how you choose to file.

How to Ensure You're Filing Properly: Get Help

Please keep in mind that this information about Series LLC tax treatment relates only to taxation at the federal level. State law can change more frequently, and your state may implement or already have state tax requirements specific to the Series LLC.

This is one of many reasons that smart Series LLC owners use qualified CPAs and attorneys to help them handle their taxes. Our experts at Royal Legal Solutions stay on top of the most up-to-date information about Series LLCs and tax law. If you still have questions about how to handle the taxes for your series LLC, you're not alone. We're here to help.

Don't wait until the Taxman comes knocking! Contact us to take advantage of your personalized consultation today.

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Preparing Your Taxes With Your Land Trusts

Land trusts are incredibly useful for real estate investors. They allow clever investors to remain anonymous, prevent lawsuits, and manage investments. They offer many more financial and legal perks.

With all of those sexy benefits, it's no wonder real estate investors want to know more about them. So this article is here to guide you through the decidedly unsexy part of land trusts: taxes.

Nobody likes to dole out any more cash to Uncle Sam than necessary. But we're here to show you the tax requirements and benefits of using a land trust. It as painless as possible. Here are quick and dirty answers to the four most frequently asked questions we get about land trusts and taxes.

1. Do I Have to File Taxes For My Land Trust?

In short: definitely. Failure to file taxes on anything that produces income is considered tax evasion, which you may know as the felony that finally landed Al Capone behind bars. While you're probably not running an illegal bootlegging operation, tax evasion on its own is a very serious matter. The last thing a real estate investor, or any business owner, needs is to get into a fight with Uncle Sam.

2. Do Land Trusts Offer Any Tax Benefits?

Land trusts absolutely come with certain tax perks. Some of the most popular are the following:

3. What Will My Land Trust Taxes Cost?

How much your land trust taxes will actually cost you is going to depend on the state the trust is formed in. If the trust is for an investment property outside of your home state, your state of residence may also have additional tax requirements. To be sure you're filing appropriately, make sure you have a good CPA.

Regardless of your level of experience, it's a good idea to have a real estate dream team that includes a CPA and qualified, detail-oriented attorney. That said, you can get an idea of your state's requirements with a cursory internet search.

4. How Do I Report My Land Trust on My Tax Return?

Because you'll receive pass-through treatment, you simply will report your taxes on your personal return. For detailed instructions, consult with one of the dream team members mentioned above. If you still haven't formed your dream team, that's okay: we can help.

Royal Legal Solutions has attorneys, tax professionals, and CPA partners that can help you navigate these tedious waters. As investors ourselves, we love helping our clients get the most out of both their land trusts and their tax preparations. To learn more about how to best take advantage of your land trust for tax purposes, take our Tax Discovery Quiz.

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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

VIDEO: 'Investor' Vs. 'Dealer': Why It Matters To The Internal Revenue Service

Many real estate investors aren't sure if they are "investors" or "dealers" in the eyes of the IRS. The distinction is important because a dealer does not enjoy the 1031 exchange benefits that an investor has.

You may not know it, but you might be disqualified from taking advantage of the 1031 exchange. You may also be subject to a 39.6% tax rate.

You can ensure that you're an investor, not a dealer, by having a corporation that owns and controls LLCs, which in turn ultimately own the assets.

If you take this approach you will not be considered a dealer by the IRS.

The IRS, notably, gets to make this decision on their own. So you need to work with a CPA and an attorney to make sure you follow these rules so that you're not surprised by huge tax consequences.

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

Investment Structures That Avoid California Tax Requirements (Video)

You're from California. You know that your state loves to tax, especially when it comes to LLCs.  Knowing how to avoid California's franchise tax is an important part of your asset protection strategy.

You have to pay $800 per year and franchise tax per LLC. This is true even if you live in California and you have a Texas LLC that only owns Texas property. You could still be subject to the franchise taxes.

One solution to this may be the Delaware Statutory Trust.The Delaware statutory trust is a trust structure and assets is not subject to the franchise taxes as the rules currently are defined by the franchise tax board. The Delaware Statutory Trust or DST is an entity that is formed in the state of Delaware and can have a series structure just like a series LLC.

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

The Benefits of Homestead Exemptions

If your state has homestead protections, never put it into an LLC. But you may put it into a trust for estate planning purposes. Every state that has homestead protections will allow a different amount for what they consider to be the exemption -- that means the amount that people can’t come after or you’re out.

 

 

Now consider the amount of homestead. If your homestead exemption is here (high) and your house is here (low), well it makes sense to pay off your entire house because we know all of that money is going to be protected from a lawsuit because the exemption tells us that nobody can get to it. If your house value is here (high) and your homestead is here (low) then what we want to do is create a lien against the property to cover that gap so it makes it look like the property is more encumbered than it might otherwise be. 

We talked about that in another video about the ways we might cover that property, whether using a home equity line of credit and another bank loan or establishing our own mortgage company to be able to loan against that. 

So always know what your homestead protections are, never transfer them to LLC, but you may do so to a trust for estate lending purposes.

Tax-Free Retirement Distributions

Tax-free retirement distributions are the Holy Grail.

You too can drink from the cup of financial providence.

You’ve worked hard your whole life. When you start taking distributions from your retirement funds, you’re going to start paying federal income tax on them.

There are some exceptions to state income taxes though. Several states don’t require you to pay state income tax at all. Retirement plan distributions are no different in these tax havens.

So, you could go and live in one of those states. Florida isn’t just a place where people go to die. The weather is a nice bonus, but the real reason to retire in the Sunshine State is the lack of state tax on income.

If you’re concerned with flooding, have red hair, or just hate being around retirees, you can choose from Nevada, South Dakota, Texas, Washington, Wyoming and Alaska.

Thirty-six states have partial income tax exemptions. These include:
1. Public Pensions and Retirement Plans. Distributions from federal or state employer plans are exempt from taxation in many states.
2. Private Pensions and Retirement Plans. 10 states offer full exclusions for private pensions and retirement plans. Some of them differ between pension and contributory plans. Others make no distinction.
3. IRAs. There are some states that don't tax any retirement plan distributions, including IRA distributions.
Tennessee and New Hampshire are states that do not tax wage income and therefore they do not tax retirement plan distributions of any kind. There are also numerous states that exclude a certain limit of retirement plan income from taxation. For example, Maine exempts the first $10,000 of income received from any retirement plan, including IRAs.

Bottom line, the place you live can save you money after retirement. Find out which of these tax-free paradises has a little waterfront lot with your name on it.

If you really want to ball in retirement, check out our previous article on how to buy your retirement home ahead of time. Spoiler alert: you can do this tax-free too.