Real Estate Investors…Can An...
Transcript of Real Estate Investors…Can An...
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Real Estate Investors…Can An LLC
Create And Support Tax Deductions?
_______________________________________ William Noll, CPA/Attorney
Yes! But first, if you have not done so, set up a limited liability
company (LLC). Then elect the LLC to be taxed as a
partnership (with at least two members) so you have an LLC-
Partnership which is both a legal and tax entity (with a low IRS
audit profile) and the best entity for real estate. If you operate
as one person, another member (to create the partnership) can be
your spouse, other family member or even another entity you
own such as a C-corporation. These can be minority low-
percentage members so you can still have total control.
Now to the topic at hand. Properly structured, with the
appropriate documents, an LLC can support expenses as tax
deductions, many of which are IRS hot spots (discussed shortly)
and typically would be more aggressive if taken as a non-entity
sole proprietor (which is also very prone to IRS audits).
What to do: Use a properly worded comprehensive LLC
Operating Agreement (OA). There are several important LLC
legal documents. But the OA is the most important one.
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The Operating Agreement is the nuclear, governing
instrument…mandating LLC business operations. Simply
put, it is the heart of the LLC!
The OA is also a private document, not exposed to the public
such as the articles of organization. The OA used, should be a
“Real Estate OA”, specifically designed for real estate
investment operations.
A properly worded OA will contain legal provisions that
document the LLC is a separate entity where the LLC affairs are
separate from the affairs of the members. These legal provisions
(along with entity formalities) will give its members limited
liability protection, therefore making it difficult for a court to
pierce the LLC entity veil (which would expose member
personal assets to attachment). This is because the LLC would
be separate and distinct from its members.
ALERT: Standard boiler-plate OA’s (which most are) do not
do this, as well as not doing below.
Tax Deduction Support: A properly worded Real Estate OA
also supports the multitude of tax saving expense/deductions
(and strategies) that are available for the absolute best tax
shelter – real estate.
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How Is This So? Because having the correct legal provisions in
the OA (per the above) separates the LLC entity from its
members, as a separate legal person. So given this, the statutory
LLC entity (separate from its members) via this legal document
(the OA), formally authorizes LLC members to incur expenses
necessary to attain the specific business purpose of the LLC as
provided in the OA (which purpose is: High-return, low-risk
real estate investing). This is summarized below.
__The LLC Entity__ You as LLC Member
Gives legal authorization to
incur expenses necessary to
attain the LLC business
purpose
S
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p
e
r
a
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With the LLC authorization,
you incur the authorized
deductible expenses, carrying
out the LLC bus. purpose
This is powerful! You will feel much more assured and
comfortable that your tax deductions are legally supported by
this legal entity (LLC) via this legal document (OA).
IRS Hot Spots: This is especially so with IRS hot spots such as
deductions for auto, home-office, entertainment, meals, travel to
find property; and especially real estate education (seminars, home
study courses, coaching programs) along with related travel to the
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educational event.
With the proper LLC documents, you can legally and
fully claim such deductions, even if you do not yet own
any investment properties and save thousands! This
could be a very troublesome area with the IRS…but now
can be resolved with a properly structured LLC entity
with complete, correct documentation!!
Conclusion-Summary: Such proper documentation can
therefore be an effective defense against any IRS attacks; or
CPA’s trying to deny you of valuable deductions. Reason: This
statutory LLC entity (separate from its members) via this legal
document (the OA), formally authorizes these deductible
expenses necessary to attain the LLC business purpose. You end
up with legal tax-saving deductions and a more successful real
estate operation...The best of both worlds.
To hear more about the hidden powers of LLC’s and save $1,000’s
come to our meeting (insert date, time and place of event)
Why Is The LLC Operating Agreement
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So Important?
_______________________________________
Bill Noll, CPA/Attorney
A Nuclear Private Document. The most important LLC
document is the Operating Agreement (OA). It is the nuclear,
governing instrument…mandating LLC business operations.
Simply put, it is the heart of the LLC.
The OA Versus The Articles. The articles of organization,
which is necessary for the filing of the LLC formation, is not
a substitute for an OA by which the members govern the LLC
business and their financial interest in the LLC. Moreover,
the articles of organization is a public document, while an
OA is private document. Therefore using the articles of
organization as a substitute for an OA would surrender a
great deal of privacy which is an essential part of total asset
protection. Because the LLC’s articles of organization are
available to the public, any provisions that are not required to
be in the articles should not be, but can be in the OA, because
it is not a public document, it’s private. However, any
provision that the OA contains should not be in conflict with
the formation state’s articles of organization. A properly
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designed OA would do this. Also, if there is a choice by state
statute between amending the OA or the articles of
organization, when such amendment is required, amend the
OA not the articles, again for reason of privacy.
What Should An Effective OA Should
Contain…Specifically For Real Estate Investments.
__Be very comprehensive for its intended business purpose
(real estate investing) containing all of the essential provisions
relating to legal, tax, accounting, including the administration
and regulation of the LLC’s affairs and the members’ rights
and powers.
__Document that your LLC is a separate entity where the LLC
affairs are separate from the affairs of the members.
Following its provisions will give its members limited
liability protection, therefore making it difficult for any court
to pierce its entity veil.
__Related to the above, give the best defense against an
attack on the use of a state statutory business entity by always
treating the LLC as a separate entity. As long as it can be
clearly shown that the members respected the entity
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separateness, the LLC existence should not be disregarded by
the courts. It is not the size of the entity, but rather the
existence of complete LLC documents (especially this OA)
which provides the protection from liability for the members
of the LLC. It is crucial to recognize this vital element in
operating an LLC.
__Some of the more specific provisions that can help
accomplish the above limited liability protection are those
that cover: LLC declaration of being separate and apart from
its members; specific business purpose of LLC; member
capitalization of the LLC in accordance with membership
percentage ownership; prohibited unilateral acts of members;
indemnification of members; transfers of member interests
(right of first refusal with buy-sell provision); arbitration of
member disputes; specific duties of members accomplishing
the LLC business purpose (including what duties certain
members should not be doing).
NOTE – FORMALITIES: Also to attain limited
liability protection and avoid the piercing of the LLC
veil, adhere to entity formalities, such as: Keeping
minutes, filing of all tax returns, no co-mingling of funds
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with a separate business checking account which should
not be used for personal expenditures, etc.
The OA should also…
__Support and helps to document numerous tax saving
strategies and elections to be an effective defense in the event
of an IRS audit, as this statutory LLC entity (separate from its
members) via this legal document (the OA), formally
authorizes these tax saving strategies and elections. This is
powerful! You will feel much more assured and comfortable
that your tax strategies are legally supported by this legal
entity (LLC) via this legal document (OA). (See prior article -
Real Estate Investors…Can An LLC Create And Support Tax
Deductions?)
To sum up, use an effective comprehensive OA to protect
you; support tax-saving strategies; defend you against the
IRS; and more… protecting your family wealth.
To hear more about the hidden powers of LLC’s and save $1,000’s
come to our meeting (insert date, time and place of event)
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LLC’s Have Great Legal & Tax Benefits -
Finally That Ideal Entity For Real Estate!
_______________________________________ William Noll, CPA/Attorney
LLC’s have all of the legal benefits of a corporation; yet all of the
excellent tax advantages of a general partnership; yet avoid the legal
disadvantages of a general partnership, yet avoid the tax
disadvantages of C corps, S corps and LP’s, including avoiding the
legal complications of LP’s and legal constraints of S-corps. More
specifically there is the following:
Legal Benefits – There is the following:
The LLC statutes of all 50 states and the District of
Columbia all recognize LLC’s as legal entities separate and
distinct from its member-owners, granting the corporate shield
of limited liability for its members, based primarily on
corporation law which has many decades of long standing
precedent in the US.
LP type protection. Legally, LLC’s also have similarities to
the long standing limited partnership (LP) with another form of
protection called “charging order” protection (which is a way to
thwart claimants from attaching your ownership shares).
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Limited liability protection for ALL of the members. LLC’s
have the corporate characteristic of limited liability for all of the
members. An LLC does not need an individual or entity (such as a
general partner) who is personally liable for debts. NO LLC member
is personally liable. This is unlike a limited partnership, where there
must be at least one general partner personally liable for all debts.
This causes the necessity of additional cost and paperwork to
incorporate the general partner. This is not necessary with an LLC.
Control with limited liability. Unlike a limited partner, any
LLC member can exercise control over daily management decisions
without the fear or actuality of losing their protected, limited
liability status.
Charging order protection like an LP. Yet without LP
pitfalls.
LLC’s are free from the qualification constraints imposed
on S-corps. The members can be corporations, partnerships, estates,
pension plans, IRA’s, and non-resident aliens. Unlike S-corps, an
LLC can have more than one class of “membership interest” (similar
to stock).
LLC’s can be used for all types of real estate transactions.
Residential rental, commercial, wholesaling, short sales,
rehabbing, new construction, sub-divisions, condo
conversations, etc.
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Tax Benefits - There is the following:
Easy entity selection. Under simple IRS check-the-box
rules, as a separate legal entity an LLC can be taxed as a sole
proprietor, as a partnership or as a corporation. But for real
estate ownership, an LLC should elect to be taxed as a
partnership and thereby be governed by the favorable tax
benefits of partnership tax law.
The LLC-partnership is the only pure flow-through entity
where the tax benefits still pass down to your 1040 even though
the LLC-partnership is a separate legal and tax entity from you.
One example is property tax losses which can be “paper” losses
because of componentizing depreciation (a non-cash paper
deduction). Such paper losses pass down to offset your other
1040 income saving you a bundle of taxes every year.
Lower IRS audit risk than other forms of ownership such as
corporations, Schedule C’s and E’s.
No IRS controversy on corporate tax-prone issues of
“reasonable compensation” or ”constructive dividends”; there are
no issues of loans to partners as taxable dividends or salaries (as
with corporations).
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No W-2 salaries. Unlike corporations, LLC-partnerships do
not have to pay salaries to partners and thus avoid payroll
recordkeeping, tax withholdings and filings. Optionally and without
the bookkeeping of W-2 salaries, simple straight guaranteed
payments could be paid to create earned income for valuable
retirement plan contributions.
No corporation limits for deducting property tax losses.
Even S-corps have limits on deducting losses with leveraged real
estate.
Avoid IRS passive loss limits. Unlike limited partners,
because LLC members can participate in management, they can side
step passive loss limits and fully currently deduct property tax losses
against other ordinary income by actively participating in property
management under Code Section 469. This is huge!
Tax-free distributions. Unlike corporations, distribution of
funds (including borrowed money) from an LLC will not result in
current tax (single or double); there is no gain recognized to a
member upon the distribution of property to the member even if it is
appreciated property (with built-in gains) where the value is higher
than its adjusted basis.
1031 tax-free exchanges. Unlike corporations, LLC’s, with
members splitting up, can much better accomplish a 1031 exchange
to defer capital gains taxes on property sales.
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Special member P&L allocations. Can allocate profit or
losses to the members in a manner that best suits the members’ tax
needs. For example, a member in a high tax bracket may want
allocated to them less of any net income or more of any net losses;
or vice versa for a low bracketed member. These special allocations
can be done in compliance with special partnership provisions under
code section 704(b). They do not at all apply to corporations and are
more restricted with limited partnerships.
In a nutshell, the intended benefits of LLC’s offer the best
of several worlds:
The corporate shield of limited liability for all of the members
Control over management decisions for all of the members
Charging order protection
All of the optimum real estate tax advantages of a partnership.
Ability to use for all types of real estate investing.
A properly structured LLC should...
Protect your personal assets
Save you substantial amounts of taxes
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Defend you against IRS attacks
Prevent legal disputes and save you legal fees and hassles
Enable you to successfully operate your real estate business.
But Most LLC’s Are Worthless! They simply do
not give you the significant dollar-saving
benefits that a well-designed& documented LLC
should give you!!
To find out why and save $1,000’s come to the
Baltimore REIA Main Event on Thursday
evening, March 17, and the workshop on
Saturday, March 19. Watch your email for
details!