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| CRE Online > Real Estate Law > Bill Bronchick > Question and Answer |
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Question by David Krejci:
I recently read one of your responses regarding L.L.C or Corp. You indicated that if you were actively engaged in business a Corp. would be more suitable than an L.L.C . You also indicated that an L.L.C was preferred if you were a passive investor. Could you please define a passive investor. Answer By William Bronchick: The Internal Revenue Code defines a passive real estate investor as one who does not materially participate in the management of the property. This definition is applicable to deduction of rental real estate losses. When I say "passive investor" in relation to an LLC, I mean as opposed to a real estate "dealer." If you are actively buying and selling real estate on a regular basis, you may be considered a dealer in real estate properties. A dealer is one who buys with the intent of reselling rather than for investment. If the IRS pegs you as a dealer, then you cannot use the installment sales method under I.R.C. §453. The installment sales will be disallowed and the entire "paper" profit is reported as ordinary income in the year of sale. The interest part of the payments will continue to be taxable in the year of receipt. Furthermore, dealers cannot depreciate or exchange real property under I.R.C. §1031. This re-characterization could be a large "hit" for the taxpayer. Consider using one or more "C" corporations for dealer properties. Since the corporate profits do not pass through to the shareholders in a "C" corporation, profits from dealer property are taxed as ordinary income, but at a lower rate than personal income tax (assuming the net income is less than $100,000). Furthermore, less information is reported on the "C" corporation tax return about these types of transactions, making it less likely for an audit. Rental properties should not be held in the same company as dealer properties for three reasons:
(2) A lawsuit arising out of your dealer activities could result in exposure of your other assets, namely the rental properties (3) A "C" corporation's income cannot be solely from passive activities, such as rental income, or it may be subject to personal holding company tax. Consider an LLC for rental properties. Disclaimer: The foregoing is not intended to be given as legal, financial or tax advice, but intended for instructional use only. If you require legal, financial or tax advice you should seek the assistance of a qualified professional.
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