Commercial real estate investors and developers alike are expected to face complicated tax issues as President Trump revamps several key tax laws.
While it’s still unclear exactly how investors will fare once the dust settles, there are several steps you can take to help you save money and avoid trouble during the next year.
1. Take A Good Look At Your LLC Or Partnership Agreement
If it’s been a while since you last reviewed the fine print in your LLC or partnership agreement, then now is a good time to bring out your reading glasses and go over it again.
Understanding the ins and outs of what you have agreed to is critical, and will help you address important tax issues that could come up in the future.
For example, do you know what a “qualified income offset provision is?”
How clearly are the roles and responsibilities of each partner defined? Are you clear on what minimum gain is? It’s not uncommon for investors to be a little fuzzy on the exact meaning of the agreement at the time it was created, but it’s critical you have a working understanding of the agreement before problems arise.
2. Remember That An LLC Is A Business, And Must Be Treated As Such
Many investors don’t think of their partnership as a business; however, as in any business, a certain amount of record-keeping must be kept. In fact, you need three sets of books when you are part of an LLC or a partnership. If you don’t have them, you may be in violation of the rules and your allocations among partners may be invalid.
For example, did you know that there are specific entries that must be recorded when you either move an asset or the LLC purchases an asset. You also need to maintain a record when money is moved in or out of the LLC.
If you’re a business accountant this won’t be a surprise to you; however most investors – even experienced ones – don’t have the knowledge or the time to enter these on the books. Spend the money to hire it out, lest you find yourself held liable at a critical juncture of your real estate career.
3. Are You A Dealer Or An Investor?
Do you know whether you are considered a dealer or an investor in terms of taxes? If you are classified as a dealer, the income or loss you accrue is considered ordinary income. However, if you’re considered an investor, then any profits or losses are viewed in terms of capital gains.
The distinction between the two depends on what your intent is when you purchase a property, how often you purchase a property and the substantiality of the investment. The IRS does go to court to get investors to pay the higher capital gains tax, which is taxed at a maximum tax rate of up to 40%. Ordinary income tax rates are a maximum of 20%, with a 3.8% net investment income tax.
Ask yourself these questions to help you decide whether or not you qualify as an investor or a dealer:
- How often do you purchase properties?
- How much money do you make through your properties vs your day job?
- What is your day job? (i.e. do you spend most of your time involved in real estate or another business)
- Are you holding the property for yourself, or for sale in your business?
- Do you have a business office for property sales?
- Do you advertise?
There are of course many more points to take into account, but it’s always a good idea to get professional advice from an accountant who specializes in commercial real estate.
4. Be Careful When Distributing Appreciated Property
Any investment properties that have been held over a period of time and have experienced significant appreciation, as a result, are termed “hot assets.” If you’re not careful, you could end up paying ordinary gains taxes.
That’s because according to the IRS C corporations (unlike S corporations, partnerships, and LLC’s) are taxed twice on all income: once when it is earned, and a second time when it is distributed among shareholders.
That means any real estate sold by the corporation will be taxed at a rate of between 15%-39% and taxed again once it is distributed to shareholders…which can have a serious impact on your net income.
5. Take Advantage Of Deductions And Tax Credits For Eco-Friendly Buildings
The Energy Policy Act of 2005 offers tax deductions and credits for commercial real estate investors that implement energy-efficient improvements.
If the improvements you make reduce annual heating and cooling energy costs by 50% and the property is placed into service by January 1, 2018, you may be eligible for a tax credit of $1.80 per square foot. You can also receive a partial deduction of up to $.60 per square foot if you implement renovations that affect the lighting, heating, cooling, or building envelope.
You may also be eligible to recover the cost of smart electric meters and smart electric grid equipment over a 10-year period unless the property already qualifies for a shorter recovery schedule.
6. Separate Short And Long-Term Investments
Short and long-term investment strategies are subject to different rules according to the IRS.
Short-term strategies like flipping, wholesaling, sandwich lease options, and other leasing strategies that are less than one year fall under self-employment, and thus need an entity that will help you reduce self-employment, federal, and state taxes.
Long-term investment activities, on the other hand, should help protect you by taking real estate losses against your active income, and reduce passive loss. You’ll also need to keep track of the deductions you’re entitled to.
7. Keep A Record Of Everything
One of the most important tips to keep in mind is the importance of keeping a record of all your expenses, transactions, expenses, etc. in an organized manner.
Not doing so could not only put you on the IRS hit list, but it could also have a seriously negative impact on your portfolio. Not only should you keep all receipts, notes, and documentation of business-related expenses, but you should also make sure to note on each receipt what the business purpose was.
You might remember now why you went to that fancy Midtown restaurant, but in three years that memory will be long gone.
Please note that canceled checks and credit card statements are not valid forms of proof according to the IRS. That’s because while the amount you paid might be listed, what the money was used for will not be specified.
Determining the best way to handle tax issues with IRS can indeed be stressful, even for experienced investors. Keeping meticulous records and ensuring you have an experienced CPA on your real estate team will go a long way towards protecting yourself in the long run.
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