The Taxes most Real Estate Investors don't think apply to them

THE TAXES THAT MOST REAL ESTATE INVESTORS THINK DON'T THINK APPLY TO THEM

In this edition, we will discuss Self-Employment and Alternative Minimum Taxes.

Sadly, we live in a whole new world of taxes and restriction. In 2005, I attended a conference for CPAs and other tax professionals that was hosted by the IRS. At that conference, the IRS official conducting the meeting was asked specifically about self-employment taxes as it applies to real estate investing. The official was noticeable amused when he said that self-employment taxes have been in the code forever but up to 2005 the IRS didn't actively enforce the tax. Then he went on to say that starting in 2005-2006, the IRS would start actively enforcing the taxability of this tax. He said that the IRS tracks all real estate transactions and that in a year or two they would be auditing and penalizing those investors who failed to file and pay the tax in the year it was due. (OUCH!)

WHAT ARE SELF-EMPLOYMENT TAXES?

Self-employment taxes (SE tax) are a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners. You figure SE tax using Schedule SE (Form 1040). (See IRS Code Section 1402 and/or IRS Publication 533).

IRS PUBLICATION 533 STATES THAT YOU ARE SELF-EMPLOYED AND MUST PAY SELF-EMPLOYMENT TAXES IF ANY OF THE FOLLOWING APPLY TO YOU:

You Carry On A Trade Or Business: A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit. The regularity of activities and transactions and the production of income are important elements. You do not need to actually make a profit to be in a trade or business as long as you have a demonstratable profit motive. You do need, however, to make ongoing efforts to further the interests of your business.

• You Are A Sole Proprietor. You are a sole proprietor if you own an unincorporated business by yourself or owned by a husband and wife.
• You Are An Independent Contractor. People who are in an independent trade, business, or profession in which they offer their services are generally independent contractors.
• You Are A Partner. If you are self-employed as a managing partner in a partnership or managing member in an LLC.
  

Husband And Wife Partners. You and your spouse may operate a business as a partnership. If you and your spouse operate a business as partners, you will report business income and expenses on form 1065, U.S. Return of Partnership Income, and attach separate Schedules K-1 showing each partner's share of the earnings. Each spouse must report his or her share of a general partnership earnings on Form 1040 and file a separate Schedule SE (Form 1040) to report SE tax. Worse yet,, if your spouse is your employee, not your partner, you must withhold and pay social security and Medicare taxes for him or her instead.

OTHER NOTEWORTHY CONSIDERATIONS CONCERNING SELF EMPLOYMENT TAXES REAL ESTATE RENT:

Rental income from real estate is NOT included in earnings subject to SE tax UNLESS either of the following applies to you.

(a). You provide services for your tenants: You personally manage your properties.

(b). You are a real estate dealer.

AS YOU CAN SEE, SELF-EMPLOYMENT TAXES APPLY TO MOST OF US

WHAT IS THE ALTERNATIVE MINIMUM TAX?

Remember back to when you were young and poor and nothing made you madder than tales of rich people who paid nothing in income taxes? Well, you weren't alone, and that anger led to the creation of something called the alternative minimum tax, which was designed to keep the rich from living tax-free.

Fast-forward a few years. You're a bit older, somewhat better off and paying far more in taxes than you ever thought possible. So what's the last thing you expect to see when you fill out your tax return? That you owe the alternative minimum tax. You can take some solace in the fact that thousands of taxpayers just like you have been snagged by this nasty bit of tax law in recent years. While only 19,000 people owed the AMT in 1970, over 4 million are paying it now.

What happened? Inflation, mostly. While the "regular" tax brackets, exemptions and standard deductions are adjusted annually for inflation, the AMT brackets and exemptions are not, so many people whose income has grown with the economy enter the dreaded AMT zone each year. Especially vulnerable are people with income over $75,000 and some large deductions, but not the exotic ones that were originally targeted by the AMT's creators. Most vulnerable are taxpayers with several children, interest deductions from second mortgages, capital gains, high state and local taxes, and incentive stock options.

How The Tax Works: The best way to understand the AMT is to view it as a separate tax system. It has its own set of rates and its own rules for deductions, which usually are less generous than the regular rules. Because of these confusing rules, the only ways you can tell if you owe the tax are by filling out the forms (essentially doing your taxes a second time) or by being audited by the Internal Revenue Service. If it turns out you should have paid the AMT but didn't, you will owe the back taxes plus any interest or penalty that the IRS decides to dole out.

You should definitely run the numbers if your gross income is above $75,000 and you have write-offs for personal exemptions, taxes and home-equity loan interest. Ditto if you exercised incentive stock options during the year, or if you own rental properties, partnership (or LLC) interests or S corporation stock or If you earn more than $100,000.

That means filling out Form 6251. In effect, you are simply adding back some tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. Here is where the middle class gets soaked. First you have to add back your personal- and dependent-exemption deductions ($3,200 each in 2005, $3,300 each in 2006), then your standard deduction if you don't itemize ($10,000 for joint filers in 2005 and $10,300 for joint filers in 2006; $5,000 for singles in 2005 and $5,150 for singles in 2006). You also lose your state, local and foreign income and property-tax write-offs, as well as your home-equity loan interest, if the loan proceeds are not used for home improvements.

The AMT also ignores some itemized deductions, such as investment expenses and employee business expenses, and some medical and dental expenses. Under the regular rules, you wouldn't pay current taxes on that amount, but under the AMT, it's considered income.

The AMT reporting form has quite a few other pluses and minuses, but you can probably ignore them unless you own a business, rental properties or interests in partnerships (or LLCs) or S corps. If you do, you may need a tax pro to prepare at least the Form 6251 part of your return.

Finally, you get to deduct the AMT exemption - $58,000 for joint filers; $40,250 for unmarried persons; $29,000 for those married filing separately. However, this exemption is reduced by 25 cents for each dollar of AMT taxable income above $150,000 for couples ($112,500 for singles and $75,000 for married filing separate status), and it's not adjusted for inflation, which is one reason why more people owe the AMT every year. (The exemption amounts for 2006 are not yet finalized, but we expect them to remain the same.)

After the exemption (if any) has been deducted, the result is subject to AMT rates - 26% on the first $175,000 ($87,500 for married couples filing separately) and 28% on the excess. Again, the AMT brackets are not adjusted for inflation, which causes much greater exposure to the tax as the years go by. If the AMT exceeds your regular tax, you have to pay the greater amount. Technically, the AMT is just the liability over and above the regular tax, and this figure is entered on line 45 on page 2 of Form 1040.

IMPORTANT NOTE: When you read this brief regarding the AMT, did you notice that you and every entity was listed as being subject to this disastrous tax EXCEPT the "C" corporation? In actuality there is a corporate AMT but it only applies should your C-Corp earn in excess of 7.5 million dollars over a three-year period. In other words for most of us, there is no reason to worry about this tax applying to our C-Corp business.

CONFUSED YET? MOST PEOPLE ARE BY THIS POINT. BUT NOT TO WORRY, OUR ESCROW PROGRAM WILL LEGALLY ELIMINATE BOTH OF THESE TAXES ALL TOGETHER.

Defer capital gains? We'll Show you how!

HOW THE ESCROW PROGRAM WORKS

In this edition we will discuss How the Escrow Program works.

The Escrow Program is unique in that it provides each program participant with a FREE Nevada corporation (valued at over $3,000.00) and transfers the participant's property into the name of that corporation. Then when the property is sold, the corporation sells it not the program participant.

THE CORPORATION INCLUDES:

* NV Secretary of State articles of incorporation
* NV Secretary of State initial list of officers
* NV Secretary of State incorporation expedite service (if needed)
* Corporation records book
* Corporation IRS EIN number
* Corporate compliance CD (includes manuals, minutes & contracts)
* Corporation address in Nevada for first year
* Bank introduction to Wells Fargo Bank in Nevada for the required corporate bank account

By selling a property titled in the name of this corporation, the program participants eliminate state and self-employment taxes immediately (See the overview on this in this Proposal or IRS Code Section 1402 and/or IRS Publication 533). In addition, the corporation pays no capital gains tax because it is IN the real estate business and the income derived from the sale is considered "ordinary income" to the corporation (The authority for this can be found by reviewing the information concerning Ordinary Or Capital Gain Or Loss in IRS Publication 544, also see the overview on this in this Proposal). Additionally, the federal taxes can be written down to almost nothing because of the many "write offs" that are available to the C-Corporation but not to an individual, an LLC or even an S-Corporation (The authority for this can be found by reviewing the information concerning Business Expenses in IRS Publication 535, also see the overview on this in this Proposal).

NOTE: Should the corporation not be able to totally eliminate its taxable income the corporation would be required to pay taxes ONLY on the NET amount remaining in the company at the end of the tax year (if any). At the end of the year, should the corporation not "spend" all its income and providing the remaining NET taxable amount did NOT exceed $50,000, the corporation would be taxed at 15%. As the program participant can plainly see, this is a far cry from the taxability that the program participant would endure if the property were sold in the name of the program participant or through a "pass-through entity" such as an LLC or "S"-Corporation.

To facilitate a smooth transaction, the program participant and CGR will enter into an agreement wherein the program participant will retain the total amount of the proceeds derived from the sale of the property less the flat fee that "CGR" will receive for providing its services.

NOTE: It is important to understand that the fee that "CGR" charges will not be paid out of the program participant's "profits" from the sale of the program participant property or from the program participant. "CGR" fees are derived from the "savings" that "CGR" will help the program participant realize and are paid directly out of the escrow.

LASTLY, simultaneously with "CGR" being paid its fee from the escrow, "CGR" will transfer the corporation records book, original corporate documentation, and all of the corporate stock to the program participant without further cost.

All in all, it is expected that the program participant should be able to retain at least 45% more of the money that the program participant would have realized from the sale had it been sold in the program participant personal name, the name of an LLC or even if the property was sold in the name of an S-Corporation.

Real Estate Dealer Status

THE IRS REAL ESTATE DEALER STATUS ISSUE

In this edition we will discuss the IRS Real Estate Dealer Status Issue.

Real Estate Dealer Status: The Internal Revenue Code defines a real estate dealer as: "An individual who is engaged in the business of selling real estate with a view to the gains and profits that may be derived from such sales. On the other hand, an individual who merely holds real estate for investment or speculation and receives rentals therefrom is not considered a real estate dealer."

Generally, a person is considered a real estate dealer if he/she has the intent of reselling rather than investment or more specifically if (1) the property is held primarily for sale; (2) the property is held for sale to customers; and (3) the property is for sale in the ordinary course of the taxpayer's trade or business (See, e.g., Winthrop, Ada Belle v. Tomlinson, 417 F.2d 905).

The determination whether your real estate activities rise to the level of a trade or business is a factual one, subject to a number of tests including the nature and purpose of the acquisition of the property, the duration of ownership, the continuity of sales and sales related activities over a period of time, the volume and frequency of sales, the extent of development or improvement on the property, the extent of soliciting customers and advertising, and the substantially of sales compared with other sources of your income.

Over the past five years we have seen an unprecedented appreciation in real estate values and a surge in real estate activity by investors seeking to capitalize on gains that have outpaced the stock market. This has brought to the forefront the issue of whether a sale of real estate would be treated as ordinary income or capital gains. Most people who bought real estate to "flip" it down the road would expect to pay only capital gains, and if they held it for more than one year, to pay only a 15% personal income tax. Furthermore, they would assume that they would have the option of doing a tax-deferred 1031 exchange or an installment sale. However, an active buyer and seller of real estate may be labeled as a "real estate dealer", which not only leads to negative tax consequences, but also severely restricts flexibility in structuring real estate transactions.

IN SHORT, if a substantial portion of your personal gross sales or net income were derived from real estate sales, then you most assuredly would be considered a real estate dealer.

NEGATIVE CONSEQUENCES OF THE DEALER STATUS

NO 1031 Exchanges:If you are considered a real estate dealer by the IRS, you become ineligible for Section 1031 tax deferred exchanges because the property owned is considered inventory.

Ordinary Income Tax Rates: Classification as a real estate dealer would subject the gain on the property to ordinary income tax rates, which cap out at 35%. Given that long-term capital gains are taxed at 15%, the affect on potential profit margins is quite significant. The use of a corporation will eliminate the self-employment tax for real estate dealers.

Self-Employment Tax: In addition to ordinary income tax rates, a real estate dealer's gain from sale of real estate IS subject to self-employment tax, which currently 15.3%. The use of a corporation will eliminate the self-employment tax for real estate dealers.

IMPORTANT NOTE: The Real Estate Dealer status would NOT apply to you if you operate your real estate business through a corporation like the one provided by Priority Services Group.

1031 Obsolete?!

THE ESCROW PROGRAM IS A SUPERIOR VEHICLE
FOR REAL ESTATE INVESTING WHEN COMPARED TO THE OUT DATED 1031 EXCHANGE

In this edition, we will discuss why the Escrow Program has rendered real estate 1031 exchanges obsolete.

1031 Exchange History: In the summer of 1990, the I.R.S. laid out in detail the procedure for turning a sale and purchase type transaction into an exchange that came to be know as a 1031 Exchange. These new rules allowed owners of certain types of like kind Real and Personal property to sell their property and buy other like kind property without immediately paying the Capital Gains Tax.

The IRS Classification Of Real Estate For 1031 Exchanges: The classification of properties to be exchanged determines if the property qualifies for Section 1031 treatment. The last two types of property shown below qualify for Section 1031-tax deferral, but the first one doesn't.

• Property held primarily for sale. ("Flipping" Property)
• Property held for productive use in a trade or business. (Business Property)
• Property held for investment. (Rental Property)

The Role Of The Qualified Intermediary:

The role of the Qualified Intermediary is essential to completing a successful exchange. The Qualified Intermediary is the glue that puts the buyer and seller of property together into the form of a 1031 Exchange.

In order to take advantage of the qualified intermediary "safe harbor" there must be a written agreement between the taxpayer and intermediary expressly limiting the taxpayer's rights to receive, pledge, borrow or otherwise obtain the benefits of the money or property held by the intermediary.

A qualified intermediary is formally defined as a person who is not the taxpayer and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer.

THE DISADVANTAGES OF A SECTION 1031 EXCHANGE

Future Tax Basis: The tax basis of replacement property is essentially the purchase price of the replacement property minus the gain, which was deferred on the sale of the relinquished property in the exchange. Thus, the replacement property includes a deferred gain that will be taxed in the future if the taxpayer cashes out of his investment.

Property, Which Does Not Qualify For A 1031 Exchange, Include: Please note that all of the types of property listed below are what creates the IRS designation of a "dealer" with the single exception of the personal residence.

• A personal residence
• Land under development for resale ("Flipping" Property - IRS Dealer Status)
• Construction or fix/flips for resale ("Flipping" Property - IRS Dealer Status)
• Property purchased for resale ("Flipping" Property-IRS Dealer Status)
• Inventory property ("Flipping" Property - IRS Dealer Status)

Replacement Property Title Must Be Taken In The Same Names As The Relinquished Property Was Titled: If a husband and wife own property in joint tenancy or as tenants in common, the replacement property must be deeded to both spouses, either as joint tenants or as tenants in common.

THE RULES OF "BOOT" IN A SECTION 1031 EXCHANGE

A Taxpayer Must NOT Receive "Boot" from an exchange in order for a Section 1031 exchange to be completely tax-free. Any "boot" received is taxable.

The Term "Boot" is not used in the Internal Revenue Code but is commonly used in discussing the tax consequences of a Section 1031 tax-deferred exchange. "Boot" is the money or the fair market value of "other property" received by the taxpayer in an exchange. Money includes all cash equivalents plus liabilities of the taxpayer assumed by the other party, or liabilities to which the property exchanged by the taxpayer is subject to. "Other property" is property that is non-like-kind, such as personal property received in an exchange of real property, property used for personal purposes. "Other property" also includes such things as a promissory note received from a buyer (Commonly used in Seller Financing situations).

THERE YOU HAVE IT: The exchange process can get complicated and has many tax traps should you violate ANY of the rules governing the 1031 Exchange process that is so popular with real estate investors today. Now let's compare what we have just learned about the 1031 Exchange process to the Escrow Program.

THE Escrow Program

The Escrow Program is NOT a deferral of the capital gains taxes you owe on the sale of each property you sell/exchange until a future date when the taxman WILL surely exact his due. It is the ELIMINATION of the capital gains taxes you would otherwise owe on the sale of each property you sell. There is a major difference between defer and eliminate. To Defer means to wait or postpone an action, such as a payment, until a later date while to Eliminate means Remove or to get rid of. Which one makes more sense to you?

Additionally, 1031 exchanges don't take into consideration the other taxes that you would be obliged to pay such as self-employment taxes or state taxes when you sell a property. These too, are totally ELIMINATED by the Escrow Program.

The authority for the Escrow Program can be found in Section 351 and several other places in the Internal Revenue Code. Additionally, because we employ a corporation (that is in the real estate business) as the entity selling the property, all of the income received in the escrow can be classified as "ordinary business income" under the IRS Code rules.

Thus the money you receive from the sale can be spent on ANYTHING that could be classified as ordinary and/or necessary for the operation of your real estate business. This includes things like employee benefit plans (for you), vehicles, health insurance, retirement plans, travel and even to buy more real estate.

Further, under 1031 rules, should you take money from the sale/exchange of a property to pay for these "ordinary business expenses" you would be required to pay taxes on the gross amount you took to pay for these items (in AFTER TAX dollars). This is not the case with the Escrow Program. In CGR Plan, you use BEFORE TAX dollars to pay for these items and pay taxes ONLY on the money left over at the end of the year.
With the Escrow Program you will find no restrictions such as "like-kind" or types of property that won't qualify. Additionally, the Escrow Program will ELIMINATE all IRS dealer status issues as well.

Lastly, 1031 exchanges will NOT provide any asset protection from predatory attorneys. However, the Escrow Program WILL.

SO, IT ALL COMES DOWN TO THIS FINAL NOTE: Use a 1031 exchange and defer your taxes until they move you into the highest tax bracket so you can pay the maximum in taxes OR use the Escrow Program and ELIMINATE the capital gains, self-employment and state income taxes right from the get go.

WITH ALL THINGS BEING CONSIDERED, I THINK YOU WILL AGREE THAT THE ESCROW PROGRAM IS SUPERIOR TO 1031 EXCHANGES.

Why is everyone recommending a corporation for Real Estate investing?

In this edition, we will discuss the basic differences between a "C"-Corp, an LLC and the "S" Corp.

We continue to hear attorneys and CPAs as well as other allegedly "knowledgeable authorities" frivolously recommend the use of an LLC or Subchapter S corporations for real estate investing, when in many cases, that ends up costing their naive clients a lot more in tax dollars. For that reason, it's time for another refresher on some of the big differences between C corporations and S corporations as well as LLCs. Here are some of the more important considerations you should ponder when evaluating which entity will suit your individual situation best.

Tax Brackets: With our country's "progressive" tax rate structure, it is very expensive to have too much income on your personal tax return. For individuals, the nominal rates go from 10% to 38.6% with actual effective rates much higher due to the phasing out of so many tax breaks as income increases.

With an S corp or LLC, all of the income flows right onto the 1040 tax return of the shareholders (members in an LLC), pushing them up into higher tax brackets. On the other hand, a C corporation has its own tax structure, ranging from 15% on the first $50,000 of NET income, to as much as 39%.

Income Taxed: With an S Corporation (or LLC), the shareholders (members in the LLC) are required to pay income tax on their share of the entity's income whether they take any money out of the entity's account or leave it there.

Phantom Income: "C" Corporations can accumulate earnings and pay taxes at the corporate level without the shareholders being individually taxed. On the other hand, if an S Corporation or LLC were to attempt to accumulate earnings, the shareholders or members of the LLC could be subject to " Phantom Income" and therefore be taxed on income not actually received. The " Phantom Income " issue is a simple concept. "Phantom Income" arises where the shareholder or member receives taxable income but no actual money (OUCH!).

Tax Savings: "C"-Corporations are entitled by law to take many tax deductions that are not available to individuals, "S"-Corporations or Limited Liability Companies (LLCs). In addition, "C" corporations have a lower federal tax rate at all levels of income up to $250,000, compared with individuals (only "pass through" entities such as LLCs and "S"-corporations pass the taxable income or losses directly to you). A corporation pays only 15% tax on the first $50,000 dollars of PROFIT (the amount of money left over after all expenses are paid).


More Deductions: IRS Section 179 expensing election is much more lucrative for owners of C corporations because they can literally multiply their total deduction by splitting their purchases of business assets among their different business entities. With an S corp or LLC, the Section 179 deduction is limited to just the one amount. Likewise, the deduction for net rental losses is magnified by using a C corp because it can use rental losses to offset all operating income. This is not the case for S corps as rental losses are subject to the 25% restrictive passive loss rules.

Employee Benefits: One of the benefits of a corporation is having it provide lucrative employee benefits that are deductible by the corp and tax free to the employees. Medical, life insurance, education, childcare, and retirement plans are just a few of the types of benefits available. The tax-free status of some of these plans is much less generous for people owning more than 2% of S corporation stock or an LLC membership than it is for the shareholders and/or employees in a C corp.

Double Taxation: Tax planners continue to spread fear concerning the potential for double taxation with C-corporations. Double taxation comes into play where after-tax earnings of a C corp are distributed to shareholders as non-deductible dividends. This is rarely a problem in small corporations (with earnings under 5 million) and/or non-publicly traded corporations because there are so many legitimate ways to pull money out of the C corp in a manner that is deductible, and thus only taxed once. Some of these are:

• Compensation Plans
• Interest Payments (includes for loans you might make to your entity)
• Lease Payments (includes vehicles, equipment, planes and real estate)
• Contributions to Retirement Plans
• Benefit Plans (including Life and Health Insurance)
• Non-Taxable Reimbursements To You for personal funds you expended on behalf of your entity.
  

Attack On the Rich: "Mean Testing" (penalizing the evil rich) is a growing trend in this country, and is most often measured by the adjusted gross income (AGI) on your 1040. People over certain income thresholds lose tax breaks and have to pay more taxes and penalties than others do. Income from an S corp or LLC will just make things worse. This is not the case with a C corp.

When it comes to the use of an LLC or "S"-Corp, an old Wendy's commercial said it best:

"WHERE'S THE BEEF"?

Welcome to Priority Services Group, LLC

For over 27 years Priority Services Group, LLC has been helping people and businesses legally increase their profitability, maximize their asset protection, limit their personal liability and successfully reduce their state and federal taxes. Inside this blog you will find a wealth of information on how Corporations, LLC's, Trusts, and Estate Plans can help you on your way to achieving financial freedom by reducing liability, maximizing asset protection, and preserving your privacy!