Craig S. Cody is an ex-NYC cop and certified public accountant of 17 years, he's a certified tax coach and business owner in his own right. Here's a few things he can speak on (one sheet also attached).
Cody has worked with a lot of businesses through out his life. The best practices he has seen, and the 3 practices that don’t tend to be done right, are here. So let’s take a look at the 3 Proactive Tax Practices:
People go out and buy a car and spend time researching it, but not looking at the tax codes on it. The average person doesn’t plan.
Are you holding your business in your name? Real Estate is best held in an LLC, but you need to talk to your own attorney to see. If it’s in a corporation, there could be tax issues when or if you go to sell.
This could be as simple as having your kids go to the properties to mow the lawn, or clean. If you’re paying them a reasonable amount, they don’t have to pay taxes on it. Their pay comes out of your income, which lowers your taxes, and they don’t have to pay taxes. It’s a win-win!
- What is the biggest mistake real estate investors make regarding taxes?
Typically, most real estate is held in a LLC. The reason for this is because as a real estate investor you fall under “ordinary income”. Basically, it’s short-term capital gain. If you’ve been in for a while, it’s just ordinary income
Some investors treat it all like it’s short-term capital gains. The problem with this thinking is the expenses of operating a business are subject to 2% threshold on schedule 8 of your tax return. They’re also subject to alternative minimum tax. This is a problem because, if you make too much money, they get added in without you getting the benefit of them.
If you do it properly, and actually in the business, then you don’t deal with those itemized deduction. The lesson is to ALWAYS document what you’re doing. This is something where we saved a client almost $80k because they were reporting their income incorrectly. More often than not, you’re in a better position by having your real estate investing business as an LLC instead of a corporation.
-Why not be a part of a C-Corporation?
A C-Corporation has the first $15k taxed at 15%. Getting that money out when you sell the property is double taxation. It’s just not efficient for a real estate investor to be a part of a C-Corporation. I just doesn’t help this kind of business.
However, if you’re using a C-Corp to manage your properties, it could work better. The best practice is having multiple LLC.
Here’s a story: There was a client who was a private business, not even an LLC, who was sued for mold injuries. The house was valued at $25k, and the verdict was $155k+ with interest. She had a pretty significant portfolio, and everything was attacked. If you umbrella it under one large LLC, you’d be safer.
- What are the tax write-offs real estate investors miss?
As a flipper, you can write off a lot of things since you’re being run as a normal business.
For example, if you have a home gym or a pool, that can be written off as a work rec area. The space you work in at your home is your home office. The gas you spend going to and from properties and locations can be written off as work expenses. Medical bills that are paid out of pocket can be written off as well.
Let’s talk about the home office for a bit, though. Take the space that you use to work in, in square feet, and compare it to the rest of the house. Let’s say your home office is 8% of your houses’s square footage. That means that 8% all of your utilities can be deducted in your taxes as a work expense: electricity, water, air conditioning, internet, etc. Your real estate taxes can be written off with that 8% as well. As long as there’s an office used exclusive to your business, it can be written off. Retirement plans can be worked in as well. If you’re working on your own, you can make a self appointed retirement plan. Food and entertainment can also be deducted.
Just keep track of your expenses. Make sure you’re keeping your receipts and keeping track of everything. Do it as you go instead of trying to pull things up at the end of the year.
-What are the limitations of the arms length transaction and self directed IRA.
The whole thing can be contributed to the LLC. Which means, the LLC owns that property. You cannot, yourself, do work on that property or it becomes an issue. You can, however, act as a lender in your own LLC. As long as you don’t have active involvement in the property, then it won’t be an issue.
Active involvement means that you, yourself, cannot be doing repairs with your hands. If there’s something you can pay someone else to do, get them to do it. IF you’re working on your own properties, you’re jeopardizing your involvement in the IRA. You can lend to other investors, as long as their not family. Tend to stay away from family!
The interests rates are subject to typical rules, 8 - 10% + a piece of gain, secure by real estate. However, this all depends on the investor. The better the track record, the less you’ll have to give and visa versa.
- What is Cross Segregation?
Let’s use a rental property worth $100k as an example. Typically, you would depreciate that building over 27.5 years. Let’s say your depreciate expenses are roughly $4k a year.
When you do a cross segregation strategy, the building gets broken up into parts. Take the property that would be depreciated over 3 years, 5 years, and so on, and depreciate it faster. Which means, over 27.5 years you’re still getting the $100k worth, but in the first few years you would 20% more expense from depreciation because it’s accelerating. From a tax perspective, that’s money that isn’t being taxed. That’s the smarter way to go for the best gains in your business.