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Real Estate Investors…Can An LLC

Create And Support Tax Deductions?

_______________________________________ William Noll, CPA/Attorney

Yes! But first, if you have not done so, set up a limited liability

company (LLC). Then elect the LLC to be taxed as a

partnership (with at least two members) so you have an LLC-

Partnership which is both a legal and tax entity (with a low IRS

audit profile) and the best entity for real estate. If you operate

as one person, another member (to create the partnership) can be

your spouse, other family member or even another entity you

own such as a C-corporation. These can be minority low-

percentage members so you can still have total control.

Now to the topic at hand. Properly structured, with the

appropriate documents, an LLC can support expenses as tax

deductions, many of which are IRS hot spots (discussed shortly)

and typically would be more aggressive if taken as a non-entity

sole proprietor (which is also very prone to IRS audits).

What to do: Use a properly worded comprehensive LLC

Operating Agreement (OA). There are several important LLC

legal documents. But the OA is the most important one.

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The Operating Agreement is the nuclear, governing

instrument…mandating LLC business operations. Simply

put, it is the heart of the LLC!

The OA is also a private document, not exposed to the public

such as the articles of organization. The OA used, should be a

“Real Estate OA”, specifically designed for real estate

investment operations.

A properly worded OA will contain legal provisions that

document the LLC is a separate entity where the LLC affairs are

separate from the affairs of the members. These legal provisions

(along with entity formalities) will give its members limited

liability protection, therefore making it difficult for a court to

pierce the LLC entity veil (which would expose member

personal assets to attachment). This is because the LLC would

be separate and distinct from its members.

ALERT: Standard boiler-plate OA’s (which most are) do not

do this, as well as not doing below.

Tax Deduction Support: A properly worded Real Estate OA

also supports the multitude of tax saving expense/deductions

(and strategies) that are available for the absolute best tax

shelter – real estate.

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How Is This So? Because having the correct legal provisions in

the OA (per the above) separates the LLC entity from its

members, as a separate legal person. So given this, the statutory

LLC entity (separate from its members) via this legal document

(the OA), formally authorizes LLC members to incur expenses

necessary to attain the specific business purpose of the LLC as

provided in the OA (which purpose is: High-return, low-risk

real estate investing). This is summarized below.

__The LLC Entity__ You as LLC Member

Gives legal authorization to

incur expenses necessary to

attain the LLC business

purpose

S

e

p

e

r

a

t

e

With the LLC authorization,

you incur the authorized

deductible expenses, carrying

out the LLC bus. purpose

This is powerful! You will feel much more assured and

comfortable that your tax deductions are legally supported by

this legal entity (LLC) via this legal document (OA).

IRS Hot Spots: This is especially so with IRS hot spots such as

deductions for auto, home-office, entertainment, meals, travel to

find property; and especially real estate education (seminars, home

study courses, coaching programs) along with related travel to the

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educational event.

With the proper LLC documents, you can legally and

fully claim such deductions, even if you do not yet own

any investment properties and save thousands! This

could be a very troublesome area with the IRS…but now

can be resolved with a properly structured LLC entity

with complete, correct documentation!!

Conclusion-Summary: Such proper documentation can

therefore be an effective defense against any IRS attacks; or

CPA’s trying to deny you of valuable deductions. Reason: This

statutory LLC entity (separate from its members) via this legal

document (the OA), formally authorizes these deductible

expenses necessary to attain the LLC business purpose. You end

up with legal tax-saving deductions and a more successful real

estate operation...The best of both worlds.

To hear more about the hidden powers of LLC’s and save $1,000’s

come to our meeting (insert date, time and place of event)

Why Is The LLC Operating Agreement

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So Important?

_______________________________________

Bill Noll, CPA/Attorney

A Nuclear Private Document. The most important LLC

document is the Operating Agreement (OA). It is the nuclear,

governing instrument…mandating LLC business operations.

Simply put, it is the heart of the LLC.

The OA Versus The Articles. The articles of organization,

which is necessary for the filing of the LLC formation, is not

a substitute for an OA by which the members govern the LLC

business and their financial interest in the LLC. Moreover,

the articles of organization is a public document, while an

OA is private document. Therefore using the articles of

organization as a substitute for an OA would surrender a

great deal of privacy which is an essential part of total asset

protection. Because the LLC’s articles of organization are

available to the public, any provisions that are not required to

be in the articles should not be, but can be in the OA, because

it is not a public document, it’s private. However, any

provision that the OA contains should not be in conflict with

the formation state’s articles of organization. A properly

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designed OA would do this. Also, if there is a choice by state

statute between amending the OA or the articles of

organization, when such amendment is required, amend the

OA not the articles, again for reason of privacy.

What Should An Effective OA Should

Contain…Specifically For Real Estate Investments.

__Be very comprehensive for its intended business purpose

(real estate investing) containing all of the essential provisions

relating to legal, tax, accounting, including the administration

and regulation of the LLC’s affairs and the members’ rights

and powers.

__Document that your LLC is a separate entity where the LLC

affairs are separate from the affairs of the members.

Following its provisions will give its members limited

liability protection, therefore making it difficult for any court

to pierce its entity veil.

__Related to the above, give the best defense against an

attack on the use of a state statutory business entity by always

treating the LLC as a separate entity. As long as it can be

clearly shown that the members respected the entity

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separateness, the LLC existence should not be disregarded by

the courts. It is not the size of the entity, but rather the

existence of complete LLC documents (especially this OA)

which provides the protection from liability for the members

of the LLC. It is crucial to recognize this vital element in

operating an LLC.

__Some of the more specific provisions that can help

accomplish the above limited liability protection are those

that cover: LLC declaration of being separate and apart from

its members; specific business purpose of LLC; member

capitalization of the LLC in accordance with membership

percentage ownership; prohibited unilateral acts of members;

indemnification of members; transfers of member interests

(right of first refusal with buy-sell provision); arbitration of

member disputes; specific duties of members accomplishing

the LLC business purpose (including what duties certain

members should not be doing).

NOTE – FORMALITIES: Also to attain limited

liability protection and avoid the piercing of the LLC

veil, adhere to entity formalities, such as: Keeping

minutes, filing of all tax returns, no co-mingling of funds

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with a separate business checking account which should

not be used for personal expenditures, etc.

The OA should also…

__Support and helps to document numerous tax saving

strategies and elections to be an effective defense in the event

of an IRS audit, as this statutory LLC entity (separate from its

members) via this legal document (the OA), formally

authorizes these tax saving strategies and elections. This is

powerful! You will feel much more assured and comfortable

that your tax strategies are legally supported by this legal

entity (LLC) via this legal document (OA). (See prior article -

Real Estate Investors…Can An LLC Create And Support Tax

Deductions?)

To sum up, use an effective comprehensive OA to protect

you; support tax-saving strategies; defend you against the

IRS; and more… protecting your family wealth.

To hear more about the hidden powers of LLC’s and save $1,000’s

come to our meeting (insert date, time and place of event)

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LLC’s Have Great Legal & Tax Benefits -

Finally That Ideal Entity For Real Estate!

_______________________________________ William Noll, CPA/Attorney

LLC’s have all of the legal benefits of a corporation; yet all of the

excellent tax advantages of a general partnership; yet avoid the legal

disadvantages of a general partnership, yet avoid the tax

disadvantages of C corps, S corps and LP’s, including avoiding the

legal complications of LP’s and legal constraints of S-corps. More

specifically there is the following:

Legal Benefits – There is the following:

The LLC statutes of all 50 states and the District of

Columbia all recognize LLC’s as legal entities separate and

distinct from its member-owners, granting the corporate shield

of limited liability for its members, based primarily on

corporation law which has many decades of long standing

precedent in the US.

LP type protection. Legally, LLC’s also have similarities to

the long standing limited partnership (LP) with another form of

protection called “charging order” protection (which is a way to

thwart claimants from attaching your ownership shares).

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Limited liability protection for ALL of the members. LLC’s

have the corporate characteristic of limited liability for all of the

members. An LLC does not need an individual or entity (such as a

general partner) who is personally liable for debts. NO LLC member

is personally liable. This is unlike a limited partnership, where there

must be at least one general partner personally liable for all debts.

This causes the necessity of additional cost and paperwork to

incorporate the general partner. This is not necessary with an LLC.

Control with limited liability. Unlike a limited partner, any

LLC member can exercise control over daily management decisions

without the fear or actuality of losing their protected, limited

liability status.

Charging order protection like an LP. Yet without LP

pitfalls.

LLC’s are free from the qualification constraints imposed

on S-corps. The members can be corporations, partnerships, estates,

pension plans, IRA’s, and non-resident aliens. Unlike S-corps, an

LLC can have more than one class of “membership interest” (similar

to stock).

LLC’s can be used for all types of real estate transactions.

Residential rental, commercial, wholesaling, short sales,

rehabbing, new construction, sub-divisions, condo

conversations, etc.

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Tax Benefits - There is the following:

Easy entity selection. Under simple IRS check-the-box

rules, as a separate legal entity an LLC can be taxed as a sole

proprietor, as a partnership or as a corporation. But for real

estate ownership, an LLC should elect to be taxed as a

partnership and thereby be governed by the favorable tax

benefits of partnership tax law.

The LLC-partnership is the only pure flow-through entity

where the tax benefits still pass down to your 1040 even though

the LLC-partnership is a separate legal and tax entity from you.

One example is property tax losses which can be “paper” losses

because of componentizing depreciation (a non-cash paper

deduction). Such paper losses pass down to offset your other

1040 income saving you a bundle of taxes every year.

Lower IRS audit risk than other forms of ownership such as

corporations, Schedule C’s and E’s.

No IRS controversy on corporate tax-prone issues of

“reasonable compensation” or ”constructive dividends”; there are

no issues of loans to partners as taxable dividends or salaries (as

with corporations).

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No W-2 salaries. Unlike corporations, LLC-partnerships do

not have to pay salaries to partners and thus avoid payroll

recordkeeping, tax withholdings and filings. Optionally and without

the bookkeeping of W-2 salaries, simple straight guaranteed

payments could be paid to create earned income for valuable

retirement plan contributions.

No corporation limits for deducting property tax losses.

Even S-corps have limits on deducting losses with leveraged real

estate.

Avoid IRS passive loss limits. Unlike limited partners,

because LLC members can participate in management, they can side

step passive loss limits and fully currently deduct property tax losses

against other ordinary income by actively participating in property

management under Code Section 469. This is huge!

Tax-free distributions. Unlike corporations, distribution of

funds (including borrowed money) from an LLC will not result in

current tax (single or double); there is no gain recognized to a

member upon the distribution of property to the member even if it is

appreciated property (with built-in gains) where the value is higher

than its adjusted basis.

1031 tax-free exchanges. Unlike corporations, LLC’s, with

members splitting up, can much better accomplish a 1031 exchange

to defer capital gains taxes on property sales.

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Special member P&L allocations. Can allocate profit or

losses to the members in a manner that best suits the members’ tax

needs. For example, a member in a high tax bracket may want

allocated to them less of any net income or more of any net losses;

or vice versa for a low bracketed member. These special allocations

can be done in compliance with special partnership provisions under

code section 704(b). They do not at all apply to corporations and are

more restricted with limited partnerships.

In a nutshell, the intended benefits of LLC’s offer the best

of several worlds:

The corporate shield of limited liability for all of the members

Control over management decisions for all of the members

Charging order protection

All of the optimum real estate tax advantages of a partnership.

Ability to use for all types of real estate investing.

A properly structured LLC should...

Protect your personal assets

Save you substantial amounts of taxes

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Defend you against IRS attacks

Prevent legal disputes and save you legal fees and hassles

Enable you to successfully operate your real estate business.

But Most LLC’s Are Worthless! They simply do

not give you the significant dollar-saving

benefits that a well-designed& documented LLC

should give you!!

To find out why and save $1,000’s come to the

Baltimore REIA Main Event on Thursday

evening, March 17, and the workshop on

Saturday, March 19. Watch your email for

details!