Just Heard A Tax "Guru's" Advice

[dvought 0]

This gentleman was saying not to use an S-Corp to flip properties, and not to segregate your flipping and long-term rentals into different companies, but to use an LLC (or actually 2 LLCs) for both at the same time. The reasoning was so you wouldn't be considered a dealer if you mixed the two techniques, because your overall goal would be to hold properties long term, and the flipping was just to fulfill a need for cash to carry the rental properties. I'm simplifying greatly, but that was the gist of it.

 

He said the only reason people use S-Corps was to save on social security taxes, but if you are classified a dealer you will be paying a lot greater taxes than that. He basically said don't use an S-Corp for real estate investment, and to only use multi-member LLCs. He was suggesting having you personally as a 95% member, and either another LLC or even a C-Corp as the minority member. (C-Corp if you wanted to deduct a lot of the fringe benefit type of things that you can only write off with a C-Corp.)

 

I have an S-Corp and two LLCs. The S-Corp is currently the sole member of the LLCs, but my tax accountant said this year we will add my other LLC as a minority member in each so that I'm not a disregarded entity for tax purposes.

 

Anyone have any insight or advice related to this?

[Dave T 0]

This gentleman was saying not to use an S-Corp to flip properties, and not to segregate your flipping and long-term rentals into different companies, but to use an LLC (or actually 2 LLCs) for both at the same time.

 

I agree that an S-Corp is not the best entity for property flipping. The LLC treated as an S-Corp for tax purposes would be better, a multi-member LLC would be even stronger than a single member LLC.

 

I disagree with the suggestion to combine both a property flipping activity and a rental activity under the same business entity. Nothing wrong with doing it. If you are flipping property, you are a dealer to real estate. The issue you want to avoid is having your dealer activity "taint" your investment activity. If you are perceived to be a dealer by the IRS, then all your real estate sales will be deemed to be dealer dispositions -- even the sales of your long term rental holdings.

 

Keeping your business activities segregated into two separate entities helps you avoid the tainting issue.

 

 

The reasoning was so you wouldn't be considered a dealer if you mixed the two techniques, because your overall goal would be to hold properties long term, and the flipping was just to fulfill a need for cash to carry the rental properties. I'm simplifying greatly, but that was the gist of it.

 

This suggestion is based upon just one of the facts and circumstances test that the IRS uses to determine if you are a dealer to real estate. There are a bunch of "tests" and predominant business activity is just one of them. The premise is that as long as the predominate business activity is holding rental property indefinitely, then the occasional property flip will not be treated as a dealer disposition.

 

You may get away with this if you only flip one property, ever. Flip a few properties, and you will establish a pattern of activity that suggests you are acting as a dealer to real estate. The length of time you hold the property and your marketing efforts to sell rather than rent will outweigh the predominate business activity test and you will be deemed to be a dealer to real estate for those transactions. Once you are deemed to be a dealer for those transactions, then you will "taint" all your legitimate investment property sales. 1031 exchange tax treatment will be disqualified, installment sale tax treatment will be disallowed, and self-employment income taxes will be assessed.

 

 

He said the only reason people use S-Corps was to save on social security taxes, but if you are classified a dealer you will be paying a lot greater taxes than that.

 

An S-Corp and an LLC treated as an S-Corp for tax purposes are both taxed the same way. The reason the to use S-Corp tax treatment is you limit the amount of income subject to self-employment taxes if you take a reasonable salary. Take no salary and ALL of the income is subject to self-employment income taxes in addition to the ordinary income taxes that you pay anyway. The single member LLC has all of its property flipping income taxed as ordinary self-employment income. So conducting your dealer activity within an S-Corp or within an LLC treated as an S-Corp will have a lower total tax liability than the single member LLC that is a dealer to real estate. The S-Corp is so widely touted because it has been around much longer than the LLC, and for a long time it was the only viable solution. The LLC is a rather new "invention" that is gaining popularity. The LLC treated as an S-Corp for tax purposes enjoys all the same federal income tax treatments available to the S-Corp.

 

 

I have an S-Corp and two LLCs. The S-Corp is currently the sole member of the LLCs, but my tax accountant said this year we will add my other LLC as a minority member in each so that I'm not a disregarded entity for tax purposes.

 

As a general rule, there is no one-size fits all solution. What you need, may not be the best solution for someone else. Whatever entity structure is best for you should be determined by consultation with your tax advisor, your CPA, your estate planner, and your financial planner. Best if you can get all these professionals in the same room at the same time to thoroughly discuss the pros and cons of the entity structuring options available.

 

 

Anyone have any insight or advice related to this?

 

You need to be aware that property flipping is a dealer activity, even if you only do it once. Concealing a property flipping business behind a rental activity will not survive IRS audit. I look at the suggestions you received as a tax evasion technique that the IRS will disallow on audit. Best to just do it right from the beginning, then you never worry about an audit.

[dvought 0]

Thanks Dave. I always take what people say with a grain of salt if it's main purpose is to sell you their "system". They have listed in their system all IRS and case law citations that supposedly back up their position, with other techniques to help avoid an audit altogether as well.

 

Some of the ideas were pretty radical - not illegal, but definitely out of the box, although as real estate investors, that's not necessarily a bad thing.

 

Thanks for the insight!

Dawn