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William Ellis, CPA
William Ellis, CPA, CPA
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Experience:  Over 15 years of experience in public accounting
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This is a difficult question regarding an idea I have to be

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This is a difficult question regarding an idea I have to be able to circumvent the risk of having my S-Corporation involuntarily terminated from deriving a large portion of my income from rental properties based on IRC 1362(d)(3)(A)(B) &(C). My situation:

-Currently own insurance agency in an SCorp
-I just started buying up rental properties in my name.
- The income derived from these rental properties over the next few years will be large.
-The rental properties are not Apartment complexes where I would be taking an active regular active roll in the maintenance. Rather the properties are single residences, duplexes, and fourplexes.
- I would love to get the tax benefits of an S-Corp by lowering my self-employment taxes. However, I do not want to involuntarily dissolve my S-Corporation or be liable for C-Corporation taxes because more than 25% of the S-Corp's income was derived from passive income. In the next few years the income derived from the rental properties will be about 90% of the total income of the S-Corp.

Here is the solution I thought up:

1. Set up a few LLC's to hold the property. When I form them I write that the objective of the LLC's is to make money in the long-term through appreciation of real estate assets while hiring a Property management company to do all the work for the rentals. This will work will include: procuring tenants for the properties, hiring repair services, etc., etc. etc.....

2. I have my LLCs contract with my S-corporation to do the property management. In return for the professional management, the S-Corp will be entitled to payment of the net profit accrued from the rents. ------Side Note-- I would also have to think of a way to exclude the portion that I can write off for a depreciation expense. Maybe I could pass only the piece of income I would get tax-free based on the annual depreciation expense through the LLC to myself because it wouldn't be income that I had to pay taxes on anyways? I might have to go deeper into this question later -----

3. I then pay myself a salary to manage both my insurance agency and property management company in the S-corp and only am responsible for self-employment taxes in the amount of my annual salary because I take the rest as a dividend.

4. When I want to sell the properties out of the LLC, I can sell them subject only to long-term capital gains tax. Thus, I would avoid excessive taxes there as well.

My question is will this fly? Has anyone successfully done this? Even made it cleanly through an audit? I have no idea because I couldn't find this idea on the internet anywhere. I realize the IRS might frown on an LLC that has a ton of properties without generating any income until they are sold. However, I thought it would be feasible to say that the goal is to make money through appreciation without dealing without doing all the work of acting as a landlord. If you think there are holes in this idea please point them out. Also, please offer any solutions you can think of as well. Thanks, XXXXX XXXXX
Submitted: 4 years ago.
Category: Tax
Expert:  Lindie-mod replied 4 years ago.

Hi

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Moderator

Customer: replied 4 years ago.
Nobody wants to answer this questions because I have not offered enough money.
Expert:  Lindie-mod replied 4 years ago.
Hi

Would you like to raise the offer amount?

Thank you
Customer: replied 4 years ago.
Yes, please change it to $30. Thanks.
Expert:  William Ellis, CPA replied 4 years ago.

Good afternoon,

 

I understand what you're trying to accomplish, but I think you're risking running into a "substance over form" issue. Form an LLP to act as a holding company, and other LLP's for each property. You can still try having the S-Corp act as the property manager. Have the LLPs show the depreciation and other operating expenses against the rental income.

 

I don't see this relieving you of your self-employment tax burden, because when you add the project management income to the S-Corp's earnings, your salary from the S-Corp will probably have a corresponding increase. That's not all bad if your salary is approaching the earnings limit making a portion of the LLP's earnings subject to Social Security tax.

 

Please remember that the health care act now requires companies to issue 1099s to every person and company it pays over $600. This means that the IRS will have a paper trail to link the transactions.

 

I hope this helps,

 

Bill Ellis

Customer: replied 4 years ago.
What do you mean a "substance over form issue"? Please explain.

Expert:  William Ellis, CPA replied 4 years ago.

In this case, "substance over form" refers to operating and showing passive income in your S-Corp. Just because you create layers to conceal the income, the substance of the actions are still showing this income in the S-Corp. If the IRS looks into the transactions and you are the sole owner of all of the entities, they could combine all of them into one entity under the substance over form doctrine.

 

Single member LLCs are disregarded entities by the IRS.

 

I'd advise you not to try to combine the activities.

 

Thanks,

 

Bill Ellis

Customer: replied 4 years ago.
So you think there is no way to avoid the 15.3% self employment tax? It comes to a lot of money.

With the LLC, what if I make my wife a partner? Would it still be disregarded by the IRS?

Expert:  William Ellis, CPA replied 4 years ago.

No, but it would be the same difference as a LLP. You'd have to either file a Form 1120 for the LLC or file a Form 1045 for the partnership.

 

Thanks,

 

Bill

William Ellis, CPA, CPA
Category: Tax
Satisfied Customers: 296
Experience: Over 15 years of experience in public accounting
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William Ellis, CPA
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Over 15 years of experience in public accounting