Month: May 2017

Should I Acquire and Hold Rental Real Estate in an LLC?

At KRS, we get this question often from both new and seasoned investors acquiring new properties. Here’s what investors need to consider.

Should you buy and hold rental real estate as an LLC?Limited Liability Company

A limited liability company (LLC) is a legal structure that provides the limited liability features of a corporation and the tax efficiencies and operating flexibilities of a partnership.

The owners of an LLC are referred to as “members.” The members can consist of two or more individuals, corporations, trusts or other LLCs. Unlike a corporation, an LLC is not taxed as a separate business entity. Instead, all profits and losses are “passed through” to each member of the LLC.

A central motivation behind investors forming LLCs is to protect the LLC’s members (owners) from personal liability for debts and claims. At its very root, an LLC is utilized to keep creditors – such as suppliers, lenders or tenants – from legally pursuing the assets of a member. There are exceptions to the limited liability, such as in cases of illegal or fraudulent activity.

Disregarded Entity

LLCs are typically taxed as partnerships, which file separate tax returns. However, a single-member LLC, owned by one individual, does not file a separate tax return, but reports the activity on the tax return of its sole owner (Schedule C for business operations or Schedule E for rental activities). LLCs with one owner are commonly referred to as a “disregarded entity.”

Do I need an LLC?

Many real estate investors and landlords often ask whether they should purchase their rental property in an LLC. I have read numerous articles by attorneys, tax advisors, real estate professionals, and insurance agents with opinions on this matter. I believe there is no “one size fits all” answer. Just as in selecting which property to acquire, where investors consider multiple factors including cash flow, appreciation, capital expenditures, interest rates, proximity to transportation and etc., there are multiple considerations in choosing whether or not to acquire a property in an LLC.

Here are factors investors and landlords should consider when making their decision:

  1. Cost – I have seen clients utilize websites that charge fees as low as $100 to form an LLC (plus state filing fees). It is not uncommon to find an attorney’s fees to form a single-member LLC (including state fees) range from $1,000 to $3,000 depending on the state of formation.
  2. Filing fees – most states have an annual filing fee to keep the LLC in good status. That fee is currently a flat $50 in my home state of New Jersey. However, in New York, the fee can range from $25 to $4,500 depending on gross revenues (disregarded LLCs in New York are subject to a $25 flat fee).
  3. Type of property – the type of property to be purchased impacts risk. For example, a single family rental in a good neighborhood is less risky than a multi-unit property or commercial property.
  4. Financing – it is typically easier to obtain financing as an individual than as a commercial entity (i.e., an LLC).
  5. Interest rates – an individual borrowing to acquire an investment property may pay a higher rate than an LLC borrowing for the same property.
  6. Insurance – an umbrella policy provides coverage beyond the basic property insurance and covers additional risks. Umbrella policies may also pay for attorneys appointed by the insurance company and paid to defend you. Depending on an investor’s risk tolerance, an umbrella policy should be considered whether the acquisition is made with or without an LLC.
  7. Net worth – without an umbrella policy, an individual with a high net worth may be exposing his or her other assets to claims of creditors of his or her rental investment.

Transferring to an LLC

Frequently an investor has already closed on a property and the question arises regarding subsequently transferring the property to an LLC. After the property has been deeded there are concerns that should be reviewed including:

  1. Mortgage – if there is a mortgage on the property, contact the lender. Many mortgages have a “due on sale” clause, which means that if you transfer ownership of the property, the lender could require you to pay the full mortgage amount.
  2. Transfer tax – transfer of real property, depending on state law, may be subject to a transfer tax. Some states may exempt the transfer to a wholly owned LLC.
  3. Title insurance – a review of the title insurance policy should be undertaken to determine if the policy continues after transfer.
  4. Leases – tenant leases should be updated to reflect the LLC, and not the individual, as the owner of the property.

Acquiring real estate in an LLC should be included in an investor’s thought process or deal checklist before an acquisition. As the projects grow in size, value and risk protection afforded by an LLC will likely make their use instinctive.

We’ve got your back

If you have additional questions about rental properties and LLCs, we’re here to help. Contact me at [email protected] or 201.655.7411.

KRS Business Insights Breakfast: Results Z to A

People don’t achieve goals, they achieve results – Jean Oursler, a.k.a., The Queen of Results

Jean Oursler, the Queen of ResultsThe June KRS Insights Breakfast featured Jean Oursler, who is a speaker, author, and one of the country’s top business consultants. Jean shared with us the RESULTS Formula, which is a new way of thinking about goal setting and growing a business.

For those who missed the breakfast, we wanted to share some of Jean’s insights.

Thinking in terms of results requires a mindset change. As Jean pointed out, “It’s our Cave Man Brain – the part of our brain that’s responsible for our survival – that keeps us from achieving results. Our Cave Man Brain is in charge of the thoughts that hold us back, for example, when you find yourself saying ‘I can’t…’ or ‘I don’t have time to…’”

Her RESULTS Formula is a 7-step process that will help to change your mindset and improve your ability to get results:

R = Ready

E = End

S = Steps

U = You

L = Levels of Learning

T = Transformation

S = Success Celebration

Key Insight: You need to tame your Cave Man Brain to achieve the results you want. The RESULTS Formula can help you do this.

The inside scoop on the RESULTS Formula

R = Ready

To achieve results, you have to be ready. Most people are not. Ready means you have decided to want more and you’re willing to do what it takes to get it.  When you’re ready, you know that you can’t do the same thing every day, and get different or better results. You realize that you must improve every day so that you can be more successful tomorrow. You’re ready for the challenges you will face as you seek results.

E= End

What are the end results you want to achieve? What do they look like? The best way to achieve something is to first visualize what outcomes you want. By starting with the end, you can work backward to figure out the best way to begin. “Don’t start at A. Start at Z and work back towards A, so that your Cave Man Brain doesn’t get involved,” said Jean.

S = Steps

What steps will you need to take to get to your results? Think about these as action steps. The more specific you make these action steps, the more likely you will achieve results. Then write these steps down and commit to them.

U = You

To achieve greater results, noted Jean, YOU need to be involved. You need to work on yourself and the specific skills that you need to achieve the results you desire.

L = Levels of Learning

As you start to acquire the skills you need to achieve results, you will be going through different levels of learning. During this time, you may feel uncomfortable or frustrated. That is all part of the process as you try new ideas and improve.

Key insight: Successful people never stop learning and growing. You have to grow to achieve. Your results will always be better if you’re on a growth path, compared to the person who stays stagnant.

T = Transform

When you go through levels of learning, you can’t help but be transformed into a new way of thinking and being. “Don’t blow through this phase, recognize it and view the change as positive,” commented Jean.

S = Success Celebration

When you achieve results, celebrate! Celebration is an anchor that helps your brain remember the successes you’ve achieved. Celebrate every success, no matter how big or small, because it reinforces why it is necessary to continue your lifelong RESULTS Journey.

The RESULTS Formula can be repeated. When you’re ready, you can begin to implement it over and over to achieve higher levels of success.

We’ve got your back

At KRS CPAs, our goal is to make it as easy as possible for you to get the advice and counsel needed, so you can focus on what matters most to you. The KRS Insights Breakfast Series offers timely and relevant information from experts like Jean Oursler, who can help you achieve the results you desire.

Visit our Insights page to subscribe to our newsletter and you’ll be notified about upcoming breakfasts plus other KRS news, events and resources.

As the Queen of Results, Jean Oursler is all about achieving unprecedented results at unprecedented speed, which helps her clients create and maintain market dominance. Jean was recently rated by the Women’s Presidents Organization (WPO) as its #1 facilitator across the globe. She has a Master’s degree in organizational development and is pursuing a PhD in business psychology. Her next book in the RESULTS! series, The RESULTS! Formula, is due out in 2017.

What Is an UPREIT ?

Real Estate Investment Trust basics

An Umbrella Partnership Real Estate Investment Trust (UPREIT) can provide tax deferral benefits to commercial property owners

Real Estate Investment Trusts (REIT) are comparable to mutual funds for real estate investors.

REITs provide an opportunity to invest in large-scale properties and real estate portfolios in the same manner mutual funds offer diversification and professional management to investors in stocks and bonds. REIT investments are touted for diversified income streams and long-term capital appreciation.

Many REITs are traded on major stock exchanges, but there are non-listed public and private REITs as well. REITs are generally segregated into two core categories: Equity REITs and Mortgage REITs. While Equity REITs generate income through rental income streams and sales of the real estate portfolios, Mortgage REITs invest in mortgages or mortgage backed securities tied to commercial and/or residential properties.

Similar to sector-focused mutual funds, REITs have been created to invest in specific real estate asset classes. Some REIT offerings targeting specific asset classes include student housing, nursing homes, storage centers and hospitals.

REIT shareholders receive dividend distributions

Shareholders receive their share of REIT income via dividend distributions. REIT dividend distributions are allocated among ordinary income, capital gains and return of capital, each with a different tax consequence to the recipient.

Most dividends issued by REITs are taxed as ordinary dividends, which are subject to ordinary income tax rates (up to a maximum rate of 39.6%, plus a separate 3.8% surtax on net investment income). However, REIT dividends can qualify for lower rates under certain circumstances, such as in the case of capital gain distributions (20% maximum tax rate plus the 3.8 % surtax on net investment income). Additionally, the capital gains rate applies to a sale of REIT stock (20% capital gains rate plus 3.8% surtax).

What is an UPREIT?

An Umbrella Partnership Real Estate Investment Trust (UPREIT) provides tax deferral benefits to commercial property owners who contribute their real property into a tiered ownership structure that includes an operating partnership and the REIT, which is the other partner of the operating partnership. In exchange for the real property contributed to the UPREIT, the investor receives units in the operating partnership.

When the UPREIT structure is used, the owner contributes property to the partnership in exchange for limited partnership units and a “put” option. Generally, this contribution is a nontaxable transfer.

The owners of limited-partnership units can exercise their put option and convert their units into REIT shares or cash at the REIT’s option. This is generally a taxable event to the unit holder.

Tax deferral opportunities

When a taxpayer sells depreciable real property in a taxable transaction the gain is subject to capital gains tax (currently a maximum of 20%) and depreciation recapture tax (25%). The capital gain tax and depreciation recapture remain deferred as long as the UPREIT holds the property and the investor holds the operating partnership units. The advantage of this structure is that it provides commercial property owners, who might have significant capital gain tax liabilities on the sale of appreciated property, an alternative exit strategy.

It is common for taxpayers to negotiate some sort of standstill agreement where the REIT agrees not to sell the property in a taxable disposition for some period of time, usually five to ten years. If the REIT sell the property in a taxable disposition, it triggers taxable gain to the taxpayer.

The taxable gain is generally deferred when the real estate is transferred to the UPREIT. Generally, the tax deferral lasts until the partnership sells the property in a taxable transaction. However, a taxable event is triggered if the taxpayer converts the operating partnership units to REIT shares or cash.

We’ve got your back

If you have questions about UPREITs or their tax implications, we’re here to help. Contact Simon Filip at [email protected] or 201.655.7411.