RE Professional

[Gretel]

Scenario: Client has 2 corporations as 100% shareholder. One is a small manufacturing company, the other creates spec homes and pre-sold homes. He also has a number of rentals. Recently he bought a lot, which needs subdividing.

He works full time in the manufacturing business and has employees running the building company. He spends some time in meeting and signing documents.

One is the liability issue, I don’t want to talk about now.

He has been advised to form a LLC for each of his single project to avoid being a RE professional. I can not see any difference if he is a single owner LLC or a Sch. E for his rentals. The IRS looks to him as an individual anyway, right?

I think he should form 2 LLC’s. One for all his rentals until the accumulated liability gets to high and one for the subdivision. The subdivision is subject to SE anyway. On the other hand if he sells the lot to his building company before subdividing it he doesn’t have to pay SE tax, only on the wages he receives anyway.

All thoughts are appreciated.

[Armando Beaujolais]

"He has been advised to form a LLC for each of his single project to avoid being a RE professional. I can not see any difference if he is a single owner LLC or a Sch. E for his rentals. The IRS looks to him as an individual anyway, right?

"I think he should form 2 LLC’s. One for all his rentals until the accumulated liability gets to high and one for the subdivision. The subdivision is subject to SE anyway. On the other hand if he sells the lot to his building company before subdividing it he doesn’t have to pay SE tax, only on the wages he receives anyway."

The real estate professional rules apply to rental activities. Rental activities are passive except for real estate professionals, where "More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated" and "more than 750 hours."

The only reason I can see to avoid being a real estate professional is if the individual has a bunch of passive losses from other activities and doesn't want rental income to be changed to nonpassive. If there are not rental activities occurring, the rules don't apply.

The other issues is "real estate dealers." That applies to SE tax. The general rule is that real estate rentals are not subject to self-employment tax. The exception is for a real estate dealer who rents property held for sale. That's considered a part of the trade or business of being a real estate dealer. Even a real estate dealer doesn't owe SE on rental income if the property is held for investment as opposed to being held for sale.

[Snaggletooth]

Capital Gains

Is there not also a "capital gains" issue for Real Estate Professionals?

If these folks buy and sell holdings, are not their profits considered ordinary income? Whereas for someone who is NOT a Real Estate Professional they could take advantage of capital gains rates?

[Gretel]

Some more reading

Thanks, Armando and Ron. I did some more reading to understand the subject a little better. This is a big grey area of factors and circumstances. To my understanding the capital gains issue is only important to a real estate dealer since the real estate professional is paying normal tax anyway on all of his transactions.

The questions I am still in doubt with is if it would make any difference being a sole proprietor or a LLC. I don't think so. I do see the need to seperate the activities: Rentals, Development and Building.

[JG EA]

Obvious

The questions I am still in doubt with is if it would make any difference being a sole proprietor or a LLC. I don't think so. I do see the need to seperate the activities: Rentals, Development and Building.

As a proponent of the obvious, let me say that forming an LLC may be a good idea to protect his personal assets, even if it won't make a difference on his tax return.

[Gretel]

Obvious

Yes, I totally agree, this is why I said in my original post I don't want to talk about the liability issue.

I still wonder if the CPA who suggested to form a LLC for each single rental to avoid Real Estate dealer or professional issues had something else on his mind. I guess I have a hard time to be clear about my problem.

Or better, maybe I think there is a problem where there is none.