There is much in the media lately about how people are making so much money in real estate right now. There are, in fact, many benefits to real estate as an investment, including tax benefits and some leverage. However, it's not the only good investment. One of our students, Richard, asks the following, very astute question:

Q: All of my financial studies point to real estate being the most robust investment for developing wealth (with its exceptional control, leverage, tax benefits, etc.). I believe I tend to gravitate toward low "people intensity" situations and -- to be honest -- would probably be more comfortable doing something like options trading, but I don't like the idea of forgoing the strongest investment vehicle based on aspects of my personality that could be changed or at least altered. Isn't there a place for getting out of one's comfort zone in order to make stronger progress towards financial goals and, in the process, to stretch one's social aptitudes? Thank you.

A: I will never change my mind on the answer to this question. The best investment is the one that suits you best. No matter how many people make money in real estate, if it doesn't suit you, it's not a good investment for you. You may do okay with it. You will just never be as successful with it as you would with something that truly fits you. The reason is that when you find an investment that is right for you, you will enjoy it, you will research it, and you will have fun with it. You will become an expert in that type of investing. Are there people right now making millions of dollars in real estate? Absolutely. There are also people right now making millions of dollars in the stock market.

Do you think the folks on Wall Street are abandoning stocks and options for real estate? Some of them are and this could get them in trouble, since it's not their area of expertise. I still maintain that you will be happier and make more money doing something that is a more natural fit for you.

That doesn't mean that once you make a lot of money in stocks that you don't end up putting some of it into real estate as a way of diversifying or hedging. It simply means that if your goal right now is to build wealth, do it using a means that works best for you, whether that be stocks, real estate, business or commodities.

Warmest regards,

Tom

The other night, I was doing my monthly teleconference call for the ProVision School of Wealth Strategy. Several questions came up about buying real estate and getting leverage for that real estate while at the same time protecting it from potential lawsuits. Brandon, one of our recent questions from our AskTom database, has this similar question:

Q: Tom, I am looking at buying a single family home for investment property. This will be my first investment property and I was wondering if I should purchase it with a business entity? I think this is probably the most wise decision, which leads me to my real question. What would you recommend for a the business entity and if its an LLC how would you recommend it be taxed? (I am a single 25 year old making about 55k a year, living with 2 roommates, and saving about $1000/month for real estate investing).

A: Which entity you use depends on both the state in which you live and the state in which you are buying the real estate. LLC's work in most states. Limited Liability Partnerships, or LLPs, work well in others. Before you go too far, I suggest you work with a qualified tax and asset protection strategist to develop a good strategy. For more about this, call Siggy in our office at 866.467.5809.

One of the questions you pose here is whether to buy the real estate in your name or in the name of the entity. I suggest you buy it in your name if you are using recourse financing. Recourse financing means that you are personally responsible for paying the debt (the bank isn't limited to going only against the property). Typically in small real estate deals, banks require you to personally guarantee the loan. If this is the case, you will get better rates if you purchase in your name and then have the title company transfer it into your entity. Just be sure they use a warranty or grant deed to transfer the property to the entity so you maintain your title insurance.

Warmest regards,

Tom

In Chapter 1 of Robert Kiyosaki's book, The Real Book of Real Estate, I told about how I decided to create my own real estate team. In fact, I found a couple of family members who were struggling in their jobs and taught them the basics of finding real estate. Richard asks the following question about this:

Q: I am struggling to find a good real estate agent and am considering training someone to find properties for me. Could you provide as many specifics as possible about how you trained your real estate finders? Besides giving them a generous commission for finding exceptional deals, what techniques did you teach them so they had the ability to find the deals you look for?

A: The key here is to develop a really good wealth strategy. You need to get very specific about your criteria. When you are clear on what you want, it's much easier to communicate this to yoru real estate agent. Of course, your finders also need to be well educated about real estate in the first place. I highly recommend Rich Dad Education courses for this. You could sign up and bring your finder as a guest to one or two of the courses.

The key being that your finders must get the education just as you must get the education. Education reduces risk, increases return and make everyone a much better investor.

Warmest regards,

Tom

Cheri wins the prize for the longest email question I have ever received. Essentially, her question comes down to this - If a friend or family member is in need of cash and has equity in their house, what is the best way to get the equity out of the house?

A: This is where a blog entry will not suffice. The answer is to sit down one-on-one with a wealth strategist and determine the best strategy based on all of the facts and circumstances for both you and your friend. The struggle I have always had with detailed questions is that I simply don't have enough information to give an appropriate answer.

One answer does not fit all in this type of a situation. Remember that investing is different than being an employee or being a consumer. It's not a matter of determining the lowest price. It's a matter of making the best investment. The cost of an investment usually includes education and professional advice. If the investment is worth making, it's worth getting the right advice from the best advisors.

So my answer isn't going to be what you probably expected. My answer is to sit down with a good wealth strategist to help you devise a plan not just for this transaction - for all of your future wealth building deals. If you would like a referral, please call our office at 866.467.5809 or send us an email at cs@provisionwealth.com

Warmest regards,

Tom

In our March teleconference, I suggested a new strategy for protecting real estate from lawsuits. Kent would like some clarification on this strategy.

Q: Dear ProVision: I have a question from your teleconference in March. You spoke of "scaring away" by using an equity line on a property which was good, but even better was to place a lien on your own property. Could you please clarify? I have listened to it several times and I am unclear on this concept and it's exact purpose and when it should or could be used. Also, from the same March teleconference: can you use your own IRA as a hard money lender to your RE business? Thank you Kent

A: The most common way someone buys real estate is to put a downpayment (typically 20-30%) on the property and borrow the remainder from the bank. Even if you put your real estate into an LLC, this still leaves your downpayment at risk in a lawsuit. My newest idea on this is to borrow the downpayment from an entity that you own. Once you purchase the property, be sure to record the loan as a second mortgage on the property with the appropriate lien documentation in place.

In doing it this way, now the LLC that owns the property has no equity in the property (except for possible growth in value, of course) and your downpayment is protected from creditors, both those on the outside of the LLC and even from your renters. Garrett Sutton, the attorney who teaches the Rich Dad Education Tax and Asset Protection course with me, calls these attacks 1 and 2. This is one of the few ways to protect you from both attacks in a single transaction. Pretty simple, actually.

Warmest regards,

Tom

The term "basis" is a very important term in the tax law. Basis determines the amount you can depreciate in a building or equipment. Basis determines how much gain or loss you recognize when you sell a property. Basis also determines how much loss you can use in a partnership or an S corporation.

Generally, basis is the amount you pay for an asset. In a partnership, your basis includes the amount you put into the partnership (contribution) plus your share of the liabilities of the partnership plus your share of income from the partnership and less any distributions you receive from the partnership and your share of partnership losses. Your basis in an S corporation is similar except you don't get basis from your share of corporate liabilities unless the liability is a loan from you to the corporation.

Luis, one of our students, asked this question. In his question, Luis referred to LLC's and S corporations. I did not address LLC's because the tax law does not address them. An LLC is taxed either as a sole proprietorship, a partnership, an S corporation or a C corporation, depending on the entity type selected by the members of the LLC. So, my answer above will work equally for LLC's taxed as partnerships and partnerships.

Of course, I have given the simplified answer to this question. You should always check with your tax advisor for the specific basis of any of your assets. In fact, your tax advisor should provide these calculations with your tax return (I know at ProVision, we always do this for our clients).

Warmest regards,

Tom

There is potentially a huge difference in taxation between a real estate dealer and a real estate investor. A dealer is taxed on his net income (income less costs) at ordinary tax rates and could also be subject to self-employment tax on this income. An investor is taxed on net income at capital gains rates. If he owns the property for more than 12 months, then the maximum tax rate is 15%. Plus, he can do a like-kind, or 1031 tax-free exchange of the property into a new property. And there is no self-employment tax for an investor. So the goal for every property owner is to have as much gain as possible from their property taxed as investment, or portfolio income.

Nick has been talking to his tax advisor who has painted the following scenario for him. Nick is asking me whether it works. (Seems perhaps like Nick is not entirely confident in his tax advisor and now wants a second opinion. Nothing wrong with a second opinion. I do wonder if you want a tax advisor in whom you are not entirely confident.) Here is Nick’s specific situation and his advisor’s recommendation:

Q: Hi Tom: Nick here again. I have been recently informed by my tax advisor that being a real estate "dealer" is NOT a good idea and we should try to avoid this status labeled by the IRS if at all possible. I understand there are ways to try to prevent the IRS from labeling my business as a real estate dealer (I currently wholesale and retail contracts/deals). One technique suggested by my tax advisor was to create two entities. The first entity would be a C-Corp. This entity would enter into all contracts and transactions. The second entity would be a LLC taxed as an S-Corp. My LLC would charge my C-Corp a fee to find and manage the deal. Example: Let’s say I (My LLC) finds a great wholesaling deal. My C-Corp enters into Contract and closes on the deal. The profit from said deal is $150,000. My LLC would then charge my C-Corp a fee of $150,000 which zeros out the profit/loss from the C-Corp thus I avoid having to pay any taxes on the C-Corp entity. Since my LLC is taxed like a S-Corp, I would deduct all expenditures ($25,000), then pay myself a salary ($25,000) and take the rest ($100,000) in dividends. Is this a viable tax strategy? Can you provide some light on this and let me know if it's okay to structure my entities this way? Thanks in advance! – Nick

A: The first challenge, of course, with this answer is whether the IRS will allow a shifting of the entire profit from a deal away from the company that did the deal (the C corp) into another company. Why would the C corp even do the deal if there is no profit? I’m not quite sure why you even need the C corp. Why not just have the S corp do the deal and not worry about the IRS? No difference in outcome. BTW, this doesn’t avoid the S corp from being a dealer and recognizing ordinary income. Other than reducing self-employment tax (which I like), I’m not sure what this structure does for you.

There are ways to split the baby, so to speak, so that some of the income is taxed as capital gain while the rest is taxed as ordinary income. For more about this, come to the Rich Dad Education Tax and Asset Protection course. You can get more information on this course by sending an inquiry to cs@provisionwealth.com.

Warmest regards,

Tom

A huge industry has cropped up over the past several years that involves recommending real estate investing inside an IRA. Some of you have heard me say that I think this is a bad idea. Jim was on our call last week when I mentioned this again. He has the following question about it:

Q: I don’t know if you’re open to this kind of communication but I’m hoping to get an answer to a question that came to mind when I heard Tom make a statement on the live event last Thursday. He said that buying real estate through a self directed IRA was silly because you are putting a sheltered asset inside another shelter. He clearly felt that buying real estate through the Self Directed IRA was a bad idea. I have money in a SD (self-directed) Roth IRA and my understanding of the SD Roth IRA is that once you satisfy the tax burden of the Roth you never pay taxes on any profits made on future investments. My question is are there ways to shelter real estate outside of the SD Roth IRA that would be as effective?
Example (as I understand it per Entrust Arizona): If I have $100K that I moved from a Traditional IRA into a Roth and I pay the tax on that $100K at say 20% leaving $80K, I can, through the SD Roth, turn the $80K into a million (or more, no limits) and never owe any tax on the $920K or more that I earn. The $920K can come from fix and flips, or even wholesale deals (as I understand it). Are there ways to shelter the $920K outside the Roth if I’m not holding the real estate but rather buying and selling or buying and flipping?
I haven’t been able to find anyone yet who is willing to give me an affirmative answer on this and I’m hoping Tom’s commitment to educating the masses will allow him to take a moment for a response.

A: I am very happy to debunk this advice. First the obvious. Doing wholesaling or flipping inside an IRA will likely be subject to the Unrelated Business Income Tax, a tax that is at a 35% federal tax rate as soon as you reach $7,500 of taxable income. Second, chances are very high that you will have engaged in a “prohibited transaction” if you do this. The reason? You are prohibited from rendering any services to your IRA. If you are doing any of the work with regard to the wholesaling or flipping, you have a prohibited transaction. Prohibited transactions result in the IRA being treated as being distributed to you plus severe penalties.

Now let’s say all you want to do is true real estate investing. You want to purchase real estate and then rent it out for the long term. This is allowed without tax inside an IRA, whether regular or Roth. There are still serious challenges with this. First is the lack of leverage. As most real estate investors know, real estate is a best an average investment if you use all of your own money. While leverage (debt) is allowed on real estate in an IRA, very few lenders will loan to an IRA as the loan cannot be guaranteed or co-signed by the beneficiary of the trust or any related party (that means you!).

Next, you lose all of the tax benefits from depreciation. A good tax advisor will show you how to create tax losses from your real estate that can offset other taxable income even while receiving positive cash flow from the rental property.

To avoid taxation on your gain, you simply enter into like-kind exchanges (also called 1031 exchanges). These can go on forever. You can still get cash out (through borrowing) and you can render any services you like. There simply is no need for a serious real estate investor ever to be taxed on cash flow or appreciation from rental real estate. And you have total control of the asset. The IRS isn’t putting restrictive rules all over you like they do when you invest through an IRA.

Long answer to a simple point. Never put a tax shelter inside another tax shelter. This is a case where two rights make a wrong. For more about this, register for my Rich Dad Education Tax and Asset Protection class (three days taught every month around the U.S.) by inquiring at cs@provisionwealth.com

Warmest regards,

Tom

Many of you are just starting out in your first business. This may be real estate investing or some other business. Hopefully, like Perrilee below, you are running your business through a limited liability company (LLC) or similar entity to protect yourself from lawsuits and judgments. Perrilee wants to know how to get money back out from the LLC that she earns in her business. She asks the following question:

Q: Tom, I have an LLC that is actually accruing money in the bank from the single family residence rentals. How do I Pay myself from this business account? Wages? If yes, for what? How do I do this? I put down money from my savings for down payments and expenses. Can I get paid back any of these expenses? Thanks, Perrilee

A: This depends on how you are taxing the LLC. Assuming you have not made an special elections (such as to tax it as a corporation), then your LLC is treated as a sole proprietorship (if you are the only member) or as a partnership (if there are two or more members). In either of these cases, you can put money into the LLC or take it out at any time. It’s unlikely you will ever incur tax by doing so. This is one of the great benefits of treating your LLC as a sole proprietorship or a partnership when you are investing in rental properties. It’s just a return of capital. Your expenses should be deductible against your rental income.

Warmest regards,

Tom

One of the most common (and overlooked) business expenses is for your car. You have the option of using the actual expenses (including some depreciation) or using the IRS mileage rate. Doug and Sandy ask the following question in this regard:

Q: Tom, I have a follow up on business vehicles. You said something about up to 80% business use. Am I right in thinking that the actual expenses are much better than the mileage deduction due to the added depreciation factor? If I have signs on the vehicle will this override any small personal usage? If we do have personal usage do we keep those miles and then reduce the depreciation by that value? We are moving into the rent and hold business.

A: I’m going to focus on the mileage vs. actual question. The IRS mileage amount includes a factor for depreciation. General rule is that if you drive a lot of miles then use the mileage deduction. If you only drive a few miles, then use the actual expenses. Signs on your car don’t make it all business. The IRS only allows the percentage use for business based on business vs. personal mileage. If you use the actual expenses, you simply multiply the total expenses (including depreciation) by your business use % to determine your deduction.

For more on maximizing your automobile deductions, visit our School of Tax Strategy at www.provisionwealth.com/products. We have an entire course focused on these tax savings opportunities. And don’t forget that your home office will affect your business mileage.

Warmest regards,

Tom