Getting started, finance and tax questions

[ready2learn]

I have been interested in REI for some time now and am about to try my hand at it.  I just have a few questions for this board.  Here is my situation.  I plan on doing wholesale and rehab flips with my investments and  I am located in Arkansas.  I will be most likely using hard money loans or a partner as I do not have the best credit. Here are my questions.

Which is best for this approach.  LLC or S corp or do you need more info?

What range of taxes should I expect to pay and is there any double taxation?

Without all of the get rich quick stuff, what are some realistic yearly incomes when I move to full time with REI if I work at it and do average deals?  A hard number range please.

Thanks in advance for helping out a new guy.  I have been reading this board for about a week and have found it very helpful.

[Bud Branstetter]

If all you are going to do is buy and sell short term for cash it doesn't make a whole lot of difference.

The range of taxes depend on your profit. You will not only be paying regular income, but self employment tax also.

Realisticly, as a newbie, I would guess 10-15K.  I know a lady that has made 300K just flipping.

[John Hyre]

Let's narrow down the question.  Check out http://www.reiclub.com/articles/choice-of-entity & then come back and let us know which way your heading!

John Hyre

[ready2learn]

Thanks for the article John.  Very informative.  For flips an S-corp seems the way to go from what you are saying.  In the scenario for S-corp what will the extra $45,000 in profit that stays in the corp. be subject to if it is left in the corp.  Also, what will it be subject to if it is pulled out for bonuses or should it just be used to reinvest.  Thanks for the info.

Jason

[karmrd]

Question for ready2learn,

I can't answer your question but I wanted to ask you one if I may.  I notice a lot of major acreage in Arkansas for sale on
Ebay for very small down payments and easy long term financing. Have you any opinions on property value and appreciation of same out there in the hills of Arkansas.

I am from Georgia.  No deals like that here.  

[Dave T]

Thanks for the article John.  Very informative.  For flips an S-corp seems the way to go from what you are saying.  In the scenario for S-corp what will the extra $45,000 in profit that stays in the corp. be subject to if it is left in the corp.  Also, what will it be subject to if it is pulled out for bonuses or should it just be used to reinvest.  Thanks for the info.

Jason

Jason,

I am certainly not an expert, but since your question has not been answered yet, I thought I might take a stab.

It is my understanding that the non-salary income from the S-Corp is treated for tax purposes as a dividend and considered as distributed to the shareholders even if it is left in the business account.   So, (in my opinion) the answer to your question is that $45K would be reported on your Schedule B as a dividend and would be taxed according to your ordinary income tax bracket.

Perhaps John Hyre will come back and correct me if this information is wrong.

[ready2learn]

Thanks for the reply Dave.  If I understand it right you are saying that whether or not the money is actually dispersed that it will be taxed as income?  How would they tax it if it stayed in the business account, just tax the corp as an individual in that income bracket since it does not go out to a specific individual?

As for the cheap land in Arkansas, definitely not for short term investment.  The large acreage in the hills would basically be for hunting lands or to lease out for hunting.  Very low appreciation but very beautiful land.  Some of the larger cities have good potential for investment but the majority of land here is farming or hunting.

[Dave T]

Once again, I am not an expert on this topic.  It is my (perhaps imperfect) understanding that an S-Corp is a "pass through" entity and, as such, all income earned by the entity is reported to the IRS on Form 1120S.  

Because the entity does not actually pay taxes in its own right, all the income is passed through to the shareholder(s) on Schedule K-1.  It is the Schedule K-1 that will tell you and the IRS how much net income you need to report on your personal 1040.  Even if no actual money leaves the business bank account, the K-1 will still report it as earned and taxable to the shareholder(s).

Just my understanding, but please consult a CPA for specific details.

[John Hyre]

Dave T explained S-corp pass-through quite correctly, as is his habit.  Sorry for delay in responding - this a very busy time of year for tax professionals!

John Hyre

[Roger J]

Let me ask you a question, ready2learn.  Why are you even worrying about forming a separate entity at this point anyway?

There is no law requiring that you have to be a corp or LLC to buy real estate.  People have been buying properties for years in their own name.

Don't get me wrong.  I'm all for have a separate business entity when the time comes for it, but that time is rarely before you even begin.  You said yourself that you're new, and just ready to "try your hand at it."  What happens if you find that you don't like it, or that it's more work/effort, etc than you are prepared for at this time?  What happens if you find that you don't even find a deal?  I hope this doesn't sound too rude, but it happens.  Newbies jump in full steam, start a company, print business cards, etc and never buy a property.

My suggestion is to just start first.  Find out if you can do this, if you like doing this, and if you can be successful doing this.  If you find that you do like doing this and it's working for you, then you can consult with you attorney and tax professional about the pros and cons of forming a LLC or corp.

Roger

[ready2learn]

Thanks Dave, John, and Roger for the replies.  Dave you have explained it all very well.  As for Roger, not rude at all, i am doing all I can to learn and you are just putting forth good info.  I do see the point in not starting any kind of corp. from the beginning.  The only thing that I have heard that the main thing that can kill somebody before getting started is a bad deal or two or liabilities where you are not protected.  Maybe this is wrong to think, but this again is just the majority of the views I have read.  If you have time I would like to hear your take on this and possibly looking back how you would have engineered your takeoff into the business.  Thanks.

Jason

[Roger J]

Jason,

Yes making a "bad" deal or two can stop anyone in their tracks, new or experienced.  Having a company won't change that fact.  The simple answer here is to know your business and don't make bad deals, whatever that exactly means to you.

You protect your liabilities through insurance.  This is true whether you own a company or you are buying real estate personally.  It's insurance that will cover you if you have any liability claims filed against you, not owning a company.  If you have a company that doesn't have insurance, not only will you be screwed, it's VERY likely that they'll still come after you personally.

The main purpose of owning a company is to separate your personal assets from your business assets.  You do this so that if the business is sued and loses, you're personal assets aren't at as much of a risk.  Also, if you are sued personally, then your business assets are not at risk.  However, here's one simple fact that is rarely reported by those promoting starting companies.  If the company is sued, especially a single owner company, you are likely to get sued personally as well.  Example:  You are driving a company car and crash into a building.  The company is responsible because it's their vehicle and they employed you.  You are responsible because YOU were the one driving the vehicle.  The real truth is that owning a company actually INCREASES your chances of getting sued.  People also form businesses for tax related purposes, but more likely to less tax friendly than more to someone just starting out.

Also, by forming a company to invest thru, you are creating a world of problems with financing.  A business must go thru commerical lenders even if the property is residential.  Commerical loans have higher interest rates, shorter terms, higher downpayments, and are harder to get.  A new company will have no credit history, so the chances of getting a loan are nil unless you PERSONALLY sign.  by personally signing, you become personally liable (and all your assets) for a higher interest, shorter term than you could have gotten on your own.

Roger

[ready2learn]

Thanks for the quick reply Roger.  Very good points and very informative.  Thank you all for answering my questions.

Jason

[BB]

My lender told me that most lenders like to close under the name of the buyer and after that you can have your attorney transfer the deed to the LLC or S-Corp. Any opinions on this?

[TSMontana]

You protect your liabilities through insurance.  This is true whether you own a company or you are buying real estate personally.  It's insurance that will cover you if you have any liability claims filed against you, not owning a company.  If you have a company that doesn't have insurance, not only will you be screwed, it's VERY likely that they'll still come after you personally.

What sort of insurance do you mean? Is there a specific type(s) of insurance we should look for besides property insurance?

Thanks,

Tom Montana