Rich Dad's Real Estate Advantages: Tax and Legal Secrets of Successful Real Estate Investors
By Garrett Sutton, Esq., Sharon L. Lechter C.P.A.
As a general rule, no. For tax reasons we don't recommend that you ever hold real estate in the name of a C corporation. Your C corporation will pay considerably more in capital gains when you try to sell that property than would a flow-through entity, such as an S corporation or an LLC (limited liability company). If your S corporation is holding the property and you are sued personally, a judgment creditor may be able to reach your shares in the S corporation and effectively take control of those shares and, through them, control of the S corporation and its assets. As well, the debt of an S corporation is not part of a shareholder's basis, thus reducing write-offs. Furthermore, transferring property out of an S corporation is a taxable event whereas it is not taxable in an LLC or LP. For these reasons we recommend that real estate be held in either an LLC or a limited partnership (LP).
Even if it doesn't own it, can / use my corporation to buy real estate?
Yes. One method is to have your corporation pay rent for an office building that you own, held in an LLC. The rent paid by the corporation is a tax deduction for the business and the income from the rent is offset by operating expenses as well as the phantom expense of depreciation. This strategy is discussed in Chapter 14.
What type of entity should I hold property in?
We recommend using either an LLC or an LP. Both offer flow-through income and taxation opportunities, and both offer excellent asset protection. In Wyoming and Nevada, for example, legislation prohibits creditors of an LLC or LP from directly seizing assets of either type of entity. Instead, judgment creditors must secure their judgment against the IXC or limited partnership by way of the charging order procedure.
What is a charging order?
A charging order is, in essence, a lien filed against the LLC or limited partnership's earnings. When profit allocations are made by either entity to their members or partners, a portion would be paid to the judgment creditor to pay down the judgment. Having a charging order placed against an LLC or a limited partnership in many states does not convey voting rights, so creditors cannot take control of the entity and, through that control, reach the assets. It is important to organize in a state such as Nevada or Wyoming which has strong charging order protections instead of a state such as California which has virtually no protection. In addition, in a situation where the entity is profitable but management decides that the profit needs to be reinvested into the entity, no distributions of profit will be made at all. However, the IRS will consider each member of the LLC (or limited partner, in a limited partnership) to have received their share of the profits and will tax them on those phantom profits accordingly. So for a creditor, not receiving a cash distribution and being taxed on the distribution it did not receive is doubly annoying. Holding real property' in either of these entities can be a great deterrent against nuisance litigation and claims.
What is a family limited partnership?
There is no such entity as a family limited partnership; there are limited partnerships that hold family assets. Beware of promoters touting the benefits of "FLPs." There is no such entity under state law. A limited partnership is all you need. (And it's all that really exists anyway.)
Should I put my family home into an LLC?
Yes. The IRS in recent years has liberalized its rules to make single member LLCs an excellent means for receiving both asset protection and the tax benefits of home ownership. Before using an LLC you will analyze whether your state's homestead laws offer acceptable asset protection. In Texas and Florida the protection is unlimited, thus minimizing the need for a primary residence LLC. In California the homestead exemption is only $75,000, thus increasing the attractiveness of a primary residence LLC.
Can I write off repairs done to my own house?
You cannot deduct the repair costs for your personal residence. But the costs of repairs or improvements for your home office are a deduction.
What can I do with my borne office in the basement?
Consider renting that portion of your home to the business as a home office. There needs to be exclusive business purpose on that part of your home (in other words, that space is not merely a pan of the dining room) and the space needs to be used in your business. It should be noted that you would only rent and not sell a part of the house to the business. Selling would involve complicated and burdensome title issues.
When a rental property is not rented, can I take that as a loss of income?
The expenses of operating the rental property including the advertising costs are still expenses. You cannot take a loss for lost revenue. You do not pay tax or receive a loss on something you don't receive.
Can I set up a management company to manage my own properties?
Yes. While you cannot be a limited partner or nonmanaging member in an LP or an LLC, respectively, and receive management fees, a separate C corporation, S corporation, or LLC may be established to assume management duties.
Can we use our vacation borne as a corporate retreat for our corporation?
Your corporation can pay a fair market value of rent for the time used as a legitimate meeting place. For more on vacation home taxation see Chapter 12.
I bought an apartment complex yesterday but don't have an LLC set up yet. The loan is in my name. Is it difficult to transfer title after the fact?
The transfer itself is fairly easy, and may be done by way of a warranty deed or quit claim deed, which is prepared and filed at the local county recorder's office where the property is located. The lender's acceptance of this may be an issue. Many mortgages have a triggering clause (called a due on sale clause) that requires the entire mortgage to be repaid if title to the property changes hands. Although you are still ultimately the owner of the property, as you own the entity and you have not sold the property but merely transferred it, as far as your bank or lender may be concerned, the property has be retitled and the mortgage repayment clause triggered.
Some banks will work with you on this-they still have your personal guarantee and a security interest in the property-while others will not, as they mistakenly think you are trying to hide assets. If your lender fits into the second category consider finding a new lender. There are companies, such as llcloan.com, that specialize in asset protection loans for real estate investors.
What is the best way to protect myself against liability for my rental properties?
We believe that a comprehensive insurance package, combined with holding the entity in an asset-protecting entity such as an LLC or a limited partnership, is the best way to go. By holding your rental properties in a good entity, such as an LLC or limited partnership, you can protect yourself personally from claims of tenants or creditors. And, with a good comprehensive insurance package, you can protect your entity from the claims of others, or from certain disasters such as fire or flooding, and ensure that you will have the money to rebuild, if necessary.
If I live in California but own property in Nevada, can I set up a Nevada company?
Absolutely. Nevada has no residency requirements for people or entities who want to use Nevada entities to operate their real estate businesses. However, bear in mind that as a California resident, and assuming you hold your property in a flow-through entity such as an LLC or limited partnership, the income flowing back to you in California will be subject to California state tax.
Assuming my investment property is betel in an LLC, can this be given to my spouse upon my death?
Yes. It can be done in many ways, from passing through in your will, being transferred pursuant to a living trust, or by holding your LLC interests as joint tenants with right of survivorship (JTROS). If you choose the JTROS or living trust route, upon your passing away the investment property will automatically be transferred to your spouse or other named beneficiary, saving the problem of having your estate probated before title can be transferred.
What type of repairs are deductible for a rental unit?
Expenses that are incurred to repair an item like fixing a leaky faucet or repairing a handrail on a stairway are deductible in the year paid. Expenses that are incurred that extend the life or improve the property must be capitalized and then depreciated. Examples of capitalizable items would be a complete new roof (as opposed to fixing a hole in the roof) or a room addition.
What are the benefits of an LLC compared to an LP for holding real estate?
The LLC provides for limited liability for all owners (members) whereas an LP only has limited liability for the limited partner. The general partner of an LP would have full liability. This can be easily overcome by forming a second corporation or LLC to serve as the general partner. In states with extra taxes on LLCs, such as California and Texas, the use of LPs (even though two entities are required for complete protection) is common.