Taxjunkie- Question re: Property Mgt company as C-corp
I presently have 2 townhomes that I hold as rental property. The current rent is exceeding my expenses including depreciation causing a taxable income (when of course I would like a loss). My AGI is only a little over 100K so if I did have a loss, I would be able to use it against my W-2 income.
My thought is this: Set up a property managment company as a C-corp. Have the C-Corp charge me 10-15% of rents. This expense will cause a loss on my Schedule E.
The C-corp will report the property management fees as income. This income will then be offset be expenses. The mgt company will need a car (ordinary and necessary in my eyes). The company car can be depreciated or I can lease one and expense it. WHAT is the best way to get a car into the corporation?
This expense alone plus office supplies and telephone will wipe most if not all of the income in the C-corp (since I only hold 2 properties).
As I acquire more properties I can have the corporation set up things like pension plans and health benefits. I know that the C-corp will get taxed at 15% on the first 50K. (I really don't think that it would have taxable income for a while). I figure that this will only save me about $1000 in taxes the first year, but I guess it grow as my income grows)
I have come up with this idea from things I have read. Do you think that this idea is feasable (taking the loss on Schedule E to the extenst allowed under the passive loss rules- and then wiping out the income with other corporate expenses in the C-corp)? Is there something that I am missing? Do you have any reccomendations to enhance this type of stategy?
Does anyone else have any experience that they would like to share.
Thanks for your help.
Adam
By the way, I am located in Delaware.
I don't know the nuisances of Delaware tax law, but can give you some guidance on the federal tax law aspects.
is the the best kind of deduction to have. The only thing better than that is a tax credit (which directly reduces, $1 of tax credit for $1 of tax liability, your tax liability) (there are only a few tax credits available to REIs, and they are not useable by all REIs).
First, although it may appear that using the C corporation is a great way to drive a loss on your Schedule E, thus reducing your wage income, it will not produce any additional tax benefit if you look at the big picture. If you are a sole proprietor, you can generally take the same deductions as you could to a corporation. If you form a single member LLC as the management company, the tax law treats it as a disregarded entity (i.e., a sole proprietor). Provided your activity rises to the level of a business, you would report the LLC deductions and management income on your Schedule C. This is better than the Schedule E situation because deduction items on Schedule C are deductions "above the line" meaning that they are not subject to the 2% AGI floor or the itemized deduction phase outs (since your income is at above $100,000 you don't have to worry about the itemized deduction phaseouts, but you may have to deal with that issue in the future). Any time you can take a deduction off the top (i.e., "above the line"
The other thing you have to worry about on Schedule E, as you pointed out, is the passive loss rules. If you are not actively managing the real estate to meet the 750 hour test, etc. in Section 469, your depreciation loss would not be useable against your ordinary salary income.
Presently, the only advantage the C corporation has (for most investors) is that it can establish a defined benefit pension plan. However, because of the actuarial costs to set up the pension plan and the yearly fees, it usually is not cost effective.
Currently, the tax law permits employees/self-employed persons of C corporations, S corporations, and LLCs to deduct 100% of their health insurance costs.
I find that the most advantageous pension plan (that is also the most cost effective) for small investors is the solo 401k plan. If you are the only employee, it is possible to contribute up to $40,000 between your salary income and the matching portion from your corporation or LLC. You are permitted to defer up to 15% of your salary in the 401k, up to $11,000 ($12,000 next year). The rest is the matching portion from your employer.
However, you should note the 401k only reduces your income tax, not your FICA (social security tax) on your wages. For example, if your salary was $73,500, you want elect to defer up to $11,000 of that salary in the 401k. That means you will only be taxed on $62,500 for income tax purposes. You will still pay the 15.3% FICA tax on the full $73,500. However, I think you can see the power of the employer portion, because if the employer matches the other $29,000, that amount is deductible by the business. Therefore, using my example, you can earn $102,500 in your business before your salary, but after paying the salary and making the maximum 401k contributions, you are only subject to income tax on $62,500. That maneuver saved you about $11,000 in federal taxes.
Hope that helps,
Taxjunkie
P.S. Regarding getting the car in the entity, the transfer of the car to your wholly owned corporation will generally be tax-free under Section 351 of the IRC unless you have a loan on the car that is inexcess of your tax basis in the car. This usually only occurs if you have a business vehicle that you previously depreciated, but which is financed.
If the transfer is to a single member LLC, the transfer is nontaxable. Whether the transfer is to a corporation or an LLC, all you need to do is change the title registration with the state.
Watch out though about how you plan on using the car. If you are using it only part time for business, the the value of the part that is used for personal purposes may be a taxable dividend or considered additional salary income by the IRS (and thus income and FICA taxable). You will have to keep good records otherwise the IRS may disallow all of the deductions attributable to the car. Check out Section 274 of the IRC to determine the substantiation requirements for the deduction.[ Edited by taxjunkie on Date 04/19/2003 ]