Mindy recently sent in the following question:

Q: HI Tom, I have aquired some stocks via a divorce. We have owned them for more than a year. Is there any way to liquidate them without paying capitol gains. Thank you, Mindy

A: Not really. When you sell yoru stocks, you will recognize capital gains equal to the difference between their original purchase price while you were married and the price you sell them at. The only exceptions to this rule are for small business stock (not traded) and for mergers of companies.

The good news is that the maximum tax rate for long-term capital gains (where you hold the asset, e.g., stock for more than a year) is only 15%.

Warmest regards,

Tom

I'm a little behind on my blog, so I'm going to answer all of Durga's questions at once. I hope you are reading this, Durga.

Q1: If I borrow from 401k to purchase my first home, would I owe tax to IRS when I sell the property with capital gain?

A1: There is no tax due from borrowing, whether from your 401(k) or from a bank. Plus, when you sell your primary residence, there is no tax so long as the gain is less than $250,000 if you are single, or $500,000 if you are married.

Q2: If I borrow from my 401k and buy a property for rental income, the income is taxed at favorable rate not ordinary rate? I do lose the tax benefits due to depreciation, don't I? How is the capital gain taxed if I plan to sell the property or do 1031 exchange? What is the plan of action needed in place if I plan to borrow from 401k to purchase my 1st investment property? I currenlty own one house. What are the disadvantages? Would you advise to go with the plan?

A2: As I mentioned in A1 above, there is no tax on borrowing from a 401(k). Since you are buying the property outside of the 401(k), you receive all of the tax benefits of ownership, including depreciation and the possibility of doing a 1031 exchange. I like this strategy for using funds from a 401(k) so long as you have the education necessary to make a good property investment.

What I don't like is buying rental real estate inside of an IRA. You are likely to lose leverage and some of your income from the real estate may actually be taxed to the IRA (due to using leverage inside of an IRA). In addition, you lose all of the tax benefits of owning real estate and when you withdraw the earnings, they are subject to ordinary income tax rates and a 1031 exchange doesn't do you any good.

Q3: How soon can one close any kind of entity if needed? Is there a time limitespecially if you are in CA that has minimum tax for LLC? Can you convert from one entity to another easily? If yes, how many times?

A3: You can close down an entity pretty much at any time. There may be tax consequences to doing so, so be sure to meet with your tax advisor ahead of time to discuss your strategy for closing down the entity. In California, I suggest you form your entity in Wyoming and register it to do business in California if you are planning to move to another state so you can take your entity with you and not have to continue paying the $800 minimum tax.

Converting from one entity to another is possible in most states. For example, most states now allow you to convert from a corporation to a limited liability company (LLC) by filing a simple form. Remember that you also have to make the proper tax elections, so be sure to work with your tax advisor on this.

Warmest regards,

Tom

Jeremy asked this question. First of all, let me suggest that you use the version, QuickbooksPro. It has features that the basic version does not have that you will want to use. There are tutorials within Quickbooks that can be very useful.

For the brand new user, we recommend two of our courses - The Basics of Bookkeeping and The Basics of Using Quickbooks. Both courses can be found on our website at http://www.provisionwealth.com/products under the School of Wealth Strategy. We designed these two courses specifically for the new Quickbooks user.

Warmest regards,

Tom

Janine asks a question that I get a lot from serious real estate investors.

Q: I have invested a lot in RD Education, and start up costs for my new Real Estate/Property Investor business. I think that I heard that I must have a rental property to get beyond "Start up" and be able to qualify for any tax exemptions for my business. -What if I have a Joint Venture Agreement and I am actively making Hard Money Loans, or if I buy and sell at least one investment property? Does either of those things qualify me as a real Property Investor who can have these start up costs as well as expensed incured? Thanks Janine

A: Start up expenses do not begin to be deductible until you start business. The question of when you start your business is the subject of many court cases. In the rental real estate business, the general concensus of the courts is that you have not started your business until you have a piece of rental real estate held out for rent. It doesn't have to be rented, but it must be ready to be rented and it must be marketed to be rented.

Think about a regular retail business. When would you say they had begun business? Not until they open their doors, right? The same is true under the tax laws.

As for hard money lending, you would really have to show a lot of loans to prove that this is a "business" and not simply an investment. For fix and flips, the same is true. Just flipping one property may not put you into the business of flipping properties. The question here will come down to your intent. Is it your intent to flip many properties or just the one?

Unfortunately, the IRS has the advantage of 20/20 hindsight. They can see your intent by looking at what you actually did. So, you might say now that you intent to build a fix and flip business. However, what if you only do the one property? Then the IRS is likely to say you were not in business.

As always, I suggest you sit down with you tax advisor and come up with a complete, long-term tax strategy. You will be far better off using a professional to help you get the most tax savings over the long term.

Warmest regards,

Tom

Vita asks the following question about rolling over her 401(k) into a self-directed IRA:

Q: Since I already have a 401k plan, and the traditional IRA account is still open with my custodian, if I intend to take a distribution from a 401k plan for the purposes of redirecting it into a retirement account, do I avoid taxation if I would get a form 5498? OR - is it the case that when I take a distribution from 401k, since is pre-tax funds, I will have to first pay the tax on the distribution made and then I can channel it into a traditional IRA (and from there, to the ROTH IRA)? What is the tax rate when taking a distribution from a 401k? Thanks,

A: If you never touch the money, that is, you direct your 401(k) administrator to directly transfer your 401(k) into your traditional IRA, there will be no tax on the transfer. This is fairly simple to do and your tax preparer should be aware how to report this on your tax return.

Warmest regards,

Tom

Nick asks the following question about his flipping/wholesale business:

Q: Hi Tom, I am a student of the Rich Dad Education Advanced Training program. I am currently interviewing attorney's and CPA's specializing in real estate to add to my Power Team but wanted to get your opinion regarding a entity question. I will be doing business in NY and will be the sole owner of my company. My initial plan is to wholesale/retail (a.k.a. buy/sell without fixing) single family residences/condo/coop properties. In the future, I will also concentrate on rental properties (a.k.a. buy/hold). However, my initial question relates to my real estate business as a “dealer”. I'd also like to take advantage of the tax benefits and deductions such as home/office, automobile, cell phone, etc. provided to business owners. What type of entity should I form for this type of (buy/sell) exit strategy? Thanks in advance!

A: I see three questions here. First, when are you a dealer and what are the tax consequences? Second, what entity should you use? Third, what should be the qualifications of your tax advisor?

A1: Because you are flipping, you are probably a dealer. The issue here is your intent. It your intent to buy and hold for appreciation or to flip the deal? Seems like you are going to flip the deal. Therefore, you are a dealer and your income is ordinary income that, without the right entity structure, is subject to self-employment tax as well as income tax.

A2: The right entity is probably an LLC (limited liability company) taxed as an S corporation. When to make the election to tax your LLC as an S corporation is a matter for you to discuss with your tax advisor.

A3: If you want a tax advisor who a) understands real estate; b) will educate you about what you need to know to maximize your deductions and minimize your taxes; c) understands the value of a tax strategy and will work with you to develop a long-term, flexible tax strategy that is specific to your needs; and d) can prepare your tax returns in such a way as to minimize your taxes and reduce the chances of an audit, then your best choice would by my firm, ProVision. You can contact us at cs@provisionwealth.com or call us at 866.467.5809.

Warmest regards,

Tom

Joe is a real estate agent and wants to know what entity he should set up for his business. Because his income will be earned income, Joe should set up an entity that will help minimize self-employment taxes. The most likely choice for this is an S corporation. With proper planning and a good tax strategy, you can seriously reduce your self-employment tax by using an S corporation. Typically, depending on the state, I recommend an LLC (limited liability company) that has elected to be taxed as an S corporation.

For more on how to use S corporations, visit our website at http://www.provisionwealth.com/products and pick up our course on maximizing the tax benefits of an S corporation.

Warmest regards,

Tom

It's not often that I get a question about gifting and gift tax. Marti, one of our students, asks the following question about a gift to her son:

Q: Hey, Tom, I'm appreciating the audio CDs This question is about gifts. Our adult son, a school teacher, wanted to have his own home. After a long story... he found building site, and a builder who would let him help with the job to save money (and increase pride). I sold the company stock I had accumulated over the years in my (former) job. This was 2009. The stock sale proceeds (after the "crash") just barely covered the land purchase at $78,000. These proceeds approximately doubled our (the parents of said son)taxable income in 2009, so I had to scramble to pay off the IRS. H&R Block prepared my return for 2009. I asked them if there weren't some law about being able to give your offspring around $12,ooo from each parent, per year, without tax consequences to someone (either the recipient or the gift-givers). They said "no", and I haven't been able to find anything about it in the 2010 IRS booklet used to guide return preparation. Currently, our return is almost finished being prepared by our usual person, who is an Enrolled Agent. He doesn't know anything about gifts and taxes, either. I know you can clarify this for me, Tom. and thanks so much.

A: I suspect your confusion stems from the difference between income tax and gift tax. You can give anyone (your son or anyone else) an annual gift of up to $13,000 without any gift tax. Gift tax is a tax on the transfer of property from one person to another. It does not directly affect your income tax. You should have filed a gift tax return (form 709) for 2009. You probably would not have incurred a gift tax, due to the lifetime exclusion of $1 million that was in effect in 2009.

I suggest you upgrade your tax advisors to a qualified CPA at least. H&R Block is fine for people who don't do investing or have a business. Same with an enrolled agent. However, for more complex situations, always use a CPA. If you would like more information about our CPAs and our tax advisory services, please contact us at 866.467.5809.

Warmest regards,

Tom

At ProVision, we love to help new investors and business owners get started and on their way to financial freedom. One of the most common issues that I'm asked is what to do tax-wise during the first year of business. Kari asked it this way:

Q: I am a new investor, setup an LLC like Robert suggested and now don't know where to start. All our money is in our names not sure how to roll it over to the company. We purchased our first home in September, rehabbed it and have renters in the home with a cashflow of about $250. All money that was out of pocket came from our current account. I was looking into getting Quickbooks which I feel will benefit us. I have been keeping all receipts for our expenses and now we have revenue. How do we get started to make sure our first year taxes go smoothly.

A: First, you are right to get Quickbooks (version Quickbooks Pro is best) and get your accounting set up properly. We have two really good courses on bookkeeping and Quickbooks that you can find on our website at http://www.provisionwealth.com/products. You have a couple of choices about how you record your contributions to your LLC. You can record it as owners equity (capital) or you can record it as a loan. There can be some asset protection benefits to recording it as a loan. Be sure that you are set up with your tax preparer to pay quarterly estimated tax payments. Also, be sure you have made the proper tax elections for your entity.

I strongly recommend that all new investors work with a tax advisor to create a long-term, flexible tax strategy. In less than a month, you can learn everything you need to know about operating your first year in such a way that it's easy for you and reduces your taxes and also protects your assets. Feel free to call us at 866.467.5809 if you would like to know more about tax and asset protection strategies.

Warmest regards,

Tom

One of the most frequent questions I am asked is how to invest in real estate through an IRA. Here is the most recent of those questions, coming from John.

Q: We are trying to use our IRA $ to invest in realestate. We have converted the IRA into a self directed IRA. Our bank will not help us with any paper work associated with real estate transactions. Our next move is to move the $ to Pensco trust company, they said that they could do the paper work, any suggestions ? P.S. we already used 5 thousand $ without propper paper work to buy a house on 3/18/2011 can you help? thanks.

A: I have never found a bank that really allows for self direction in an IRA, despite what they may call it. Penso, Entrust, Sterling Trust and others do allow this. I suggest you move quickly into one of these IRA Trustees to clean up the paperwork from the first transaction and handle new transactions.

That said, allow me to share a few thoughts about investing in real estate through an IRA. Remember that an IRA is a tax shelter that defers your taxes to a later year. Investment (buy, hold and rent) real estate is also a tax shelter. So, by purchasing real estate in your IRA, you are buying a tax shelter within a tax shelter. This effectively cancels out all of the benefits of the real estate tax shelter, which are far greater than the benefits of the IRA.

If you are buying properties to improve and flip, then DO NOT use an IRA for this. You will almost for sure end up with a Prohibited Transaction, which will result in penalties, tax and interest on your IRA.

My best solution is to look at whether it makes sense to distribute the IRA money, pay the ta and penalty, and invest in the real estate outside of the IRA. An example of this can be found in our course, Managing Your IRA, at http://www.provisionwealth.com/products.

Warmest regards,

Tom

One of the best ways to speed up your bookkeeping process is to integrate your bookkeeping software with your online banking. You can simply download all of your banking transactions directly into your bookkeeping software. Sometimes, there are challenges with this such as the one posed by Alice, one of our students.

Q: Recently I found that my Bank of America accounts would not exchange data with Intuit, the parent company of Quickbooks. This was a new development. Previously the data had exchanged. Does this mark a trend of financial institutions refusing to exchange data with data consolidation programs such as Quickbooks? Will this make Quickbooks less useful in the future? Is there an alternative to Quickbooks that I should be considering?

A: There is a quick fix for this. I had the same challenge recently. Go into Quickbooks and into the Online Banking screen and reset the banking institution. You will probably have to get back out of Online Banking and then get back in and it should reset. If you have further questions, contact Intuit. This worked for me and I also use Bank of America.

Warmest regards,

Tom