Asset Protection for Flippers

Mike: Welcome back to the FlipNerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.

Clint: Hi, my name is Clint Coons, host of the REI Classroom and managing partner of Anderson Business Advisors and Law Group. And today I want to discuss what is the appropriate entity for flippers.

Mike: This show was sponsored by PassiveRental.com.

Clint: There’s a lot of information out there about what entity you should use for flipping real estate. I want to start this off by telling you a story about an individual here in Washington State where one of my offices is located. Now this individual, he went to an attorney and asked him, “Which type of entity should I set up for my flipping business?” The attorney told him what most attorneys do is set up a limited liability company because the attorney was just focused on the asset protection component of his business.

Now, when it came to taxation, the attorney recommended he go and seek advice from a CPA. This flipper then went and talked to a CPA and the CPA told him, “You should have your LLC taxed as an S-Corporation.” And that CPA laid out all this information showing him how if you have the entity taxed as an S-Corporation you could pay yourself a salary for running this flipping business, and that salary, of course, is subject to employment taxes; you know that 15.4% you get tagged with. And then, you can take a larger portion as a distribution, and it’ll just be subject to ordinary income taxes.

So in the case where you made $100,000.00, if you paid yourself a $50,000.00 salary, you would have to pay employment taxes on that, but the distribution that came out to you would not be subject to that 15.4%. So in essence, you would save $7,500.00 in taxes by setting it up as an S-Corporation.

Now, this investor came to me, and sat down with me, and he told me what he had been explained to by the attorney and the CPA. He said, “Clint, what is your recommendation?” I told him, “You need to start with a C-Corporation.” Now, he looked at me, he said, “I really don’t understand why you would recommend a C-Corporation because both the attorney and the CPA told me to avoid C-Corporations because of that nasty word ‘double taxation.'” Now see, this is a problem. You’ve got an attorney and you have a CPA, and neither one understands real estate investors and flippers, and what their needs are.

I looked at him, and I said, “Let me ask you this, what is your primary concern as a flipper?” And he said, “Having access to capital.” And I said, “Great. I’m looking at your asset sheet here, and I see you have $400,000.00 in equity in your house and you can’t touch it, can you?” And he was shocked that I knew that. I said, “It’s because of the way you file your tax return. Right now, everything is on your Schedule C, and when you go in to get a loan, lenders don’t want to loan to you because they don’t like your type of business. Am I not correct there?” And he said, “That’s absolutely right. And that’s why I’ve been using hard money and paying 12% interest rates.” I said, “Would you like to get out of that? How about if we could get you into traditional financing where lenders love the way you look on paper?” He wasn’t sure how I could do that. I said, “Well, the way you do it is you take all of that activity out of your name.”

If you set up an LLC that’s taxed as an S-Corp, that is a pass-through entity. All of that activity will show up on your tax return. And what makes matters worse, when you go in to get a loan, let’s say you want to gain access to that equity in your house, you want to get a home equity line of credit? The lenders not only going to want to see your 1040, they’re also going to want to see your business tax return because they know you have a business now. It’s going to be on your tax return as a K1. Now, I don’t know about you, but when I run my businesses, I run them for Clint’s benefit. That is I have a C-Corporation set up and my objective is to expense out everything I can through that corporation.

Well, here’s the problem, if you’re expensing out all of the income, how does your corporation look to the lender? It looks like it doesn’t make any money. So then, they look at you and think, “Well your business isn’t very profitable so how could we loan to you when you’re not making any money in your flipping business?” And then you have to sit back and explain to them, “Well, don’t look at my tax returns. Let me tell you, I really do have the cash, here’s how I run it.” Then they might think that you’re cheating on your taxes.

Listen, if you’re flipping real estate and you want to have access to cash with traditional lending and not pay those high interest rates, set up a C-Corporation, get that activity off your return. With a C-Corporation, nobody knows that you run the business and own the business because that information will not flow down onto your personal 1040. Granted, the money you take out of the C-Corporation will all come out at as a salary.

But hey, here’s the thing about salaries, W2 income looks awesome to lenders. They want to see people that have big fat paychecks because you fit in one of their boxes then that they’re accustomed to dealing with. They don’t like dealing with small business owners because they’re riskier.

So by having a C-Corporation set up, it won’t appear on your 1040, you take a big, fat paycheck out of your corporation as a salary, so you can run the rest of the income any way you want. They’ll never know that you have it, and you’ll look much better, and you’ll be able to qualify for those lower interest rate loans. My name’s Clint Coons of Anderson Business Advisors and Law Group and I look forward to seeing you next time.

Mike: PassiveRental.com is your source for turnkey, done-for-you rental properties. If you’d like to be an investor and not a landlord, please visit PassiveRental.com. To learn how to purchase cash flowing, professionally managed rental properties in the hottest rental markets across the country. We can also help connect you with financing for your next property. Invest the easy way today and get started by visiting PassiveRental.com.

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