LLC & Self Employment Tax
I am reading up on getting an LLC set up properly. I came across a section that states that an LLC could be subject to self-employment taxes at a rate of 15.3%. Is this accurate? What effect could this have on an LLC that is holding a rental property being managed by an external property management firm?
I am still trying to work out the benefits of an LLC and appreciate any help in this matter.
Thanks,
JS. 
Rental property operation is a passive income activity and self-employment taxes do not apply. If your LLC is treated as a disregarded entity, then your rental activities pass through to Schedule E (1040).
If your LLC is engaged in an active income activity, then your income and expenses pass through to Schedule C (1040) AND your self-employment taxes are computed on Schedule SE (1040).
Does this help?
My CPA said that if I only do 2 flips per multi-member LLC annually, she did not believe the return would be auditied for self-employment taxes. The reporting would be a summary format.
So I plan on setting up multiple LLCs and keeping my rentals seperate. Any feedback on this strategy?
ItzMe
Reading between the lines, your CPA is saying that if your return is audited, you will be assessed self-employment taxes. Ask your CPA if you follow her advice and you are audited, will she pay all your back taxes, penalties and interest due?
Setting up multiple business entities may be a good idea for asset protection issues, but the incorrect tax treatment on your flip profits will still get you in trouble even if you use a separate business entity.
You may be right about the self-employment taxes. Our "plan" is to include two rental properties per LLC and comingle the income. Thus, the income would not be only flippers, but the passive rental income.
Her opinion is that the probability of my being audited is extemely low. I do realize that all properties could be deemed dealer assets.
But then again, who is to say that the two flippers are dealer properties?
ItzMe
What about if you formed an S-Corp
Took a reasonable salary and then distributed the rest as a dividend avoid the SE issues. Or at least minimize them. At least this way you dont have to be concerned about being audited.
Quote:But then again, who is to say that the two flippers are dealer properties?
ItzMe,
Here are just a few possibilities:-That close friend with whom you just had a falling out
-Your significant other after the relationship breaks up
-A coworker you just angered one too many times
-Another "investor" who, when audited by the IRS, says "ItzMe told me this is how its done. He's been doing it this way for years and no one ever said it was wrong".
-You just did in this public forum.I know that you will probably just do what you want to do anyway, but don't come to this forum to try to justify or rationalize a tax evasion scheme.
DaveT,
Could you please advise me on the difference between an active income and a passive income with regards to tax purposes? Does the passive income rule apply only to rentals or does it apply to all forms of real-estate transactions?
Thanks for your insight.
JS.
smithj2,
The rules on "dealer" and "investor" status apply to dispositions of property, not just real estate. In that way, these rules apply to more than just rental properties.
As far as what is active (dealer) and passive (investor) income, court decisions are all over the map and the Treas. Regs do not provide much help. You are left to general statements and a good bit of guessing as to whether a certain transaction may be recharacterized as dealer property.
Very, very generally some factors that will be considered include the following: 1) Intent (IRS attempt at mind-reading); 2) Duration of ownership; 3) Manifestations of Intent (from message board posts?); 4) Advertising, use of agents to sell; 5) Number of past sales; 6) Extent of subdivision or development (rehab); 7) Use of business office; and Time devoted to sales.
There are other factors, and again it is different from court to court and decision to decision. This is a very murky area of the law.
At a very general level, flips are dealer property and subject to self employment tax and rentals are not. However, how your state/court sees the factors they apply may change this in your particular situation.