Learn about the big s-corp and real estate “no no” on Tax Hacker Tuesday! Tim Berry and Matt Theriault share the best and most secure way to hold a rental property, the dangers of using a corporation to hold your real estate, and how to avoid one of real estate’s biggest “no no’s.”
What You Will Learn About The S-Corp and Real Estate “No No!”:
- Why you might want to think before putting rental properties inside of corporations
- The best and most secure way to hold rental real estate
- The worst way to hold rental real estate
- How an s-corp could ruin your depreciation deductions
- How removing a rental property from an s-corp could hurt your wallet
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Speaker 1: This is Theriault Media.
Did you know that up to 50% of your lifetime income will be wiped out by taxes? What if you could stop this madness? Isn’t it about time you play on a level playing field with the wealthiest 1%?
Now, you can. Tim Berry, attorney-at-law, shares here each and every week current tactics and strategies that anyone can implement to hack the tax code. Protect your assets and keep what’s rightfully yours. It’s time for Tax Hacker Tuesday.
Matt Theriault: All right. Welcome to the Epic Real Estate Investing Show. It is Tax Hacker Tuesday with my attorney and friend, Tim Berry. On Mondays here at Epic, we show you new and creative ways as well as time honored ways of making money using real estate. On Tuesdays, we gather here to show you how to keep it. If you have a question for Tim, you can go to taxhacker.com/questions. Post it there and we’ll answer it right here live on the show. Tim, welcome back.
Tim Berry: Well, thank you much, Matt. Nice to have been here.
Matt: Yeah, it’s always nice to connect with you. You actually lift my spirits if you didn’t know that.
Tim: Well, thank you.
Matt: You’re such a happy guy, and I like it, and everything’s funny to you, which I think makes me laugh in return.
Tim: Thanks, I think.
Matt: No, I think that’s a good quality actually. Super. I know we’ve got a few things that you wanted to discuss. What are we going to talk about today’s episode?
Tim: What are we going to talk about in today’s episode? Gosh. We can talk about all sorts of things, but one that I think is a big one that I see quite a bit whenever I’m talking to people is some people are putting rental properties inside of corporations and they even compound their … Those are S corporations. That causes all sorts of issues. I guess that could be a really exciting, uplifting topic we could talk about and maybe even laugh over it too.
Matt: I’m down.
Tim: Cool. Should I start rambling on about it? What do you want me to say, Matt?
Matt: That’s a common question. People get different types of information from different sources on what’s the best entity or what’s the best strategy in using an entity. When it comes to rental real estate S corps, C corps, LLCs, sometimes people are just saying that if you got a good insurance policy that’s going to be sufficient enough. What’s the best, most secure way to hold rental real estate?
Tim: The best and secure way to hold rental real estate just depends upon the situation, but I’m going to be a diplomat and answer the question I want to answer as opposed to the one you asked.
Matt: Very good.
Tim: What I’m going to say is the worst way to hold rental real estate is probably the S corporation. The reason I’m making a big deal about this is that with an S corporation, or let me take a couple of steps back. If a regular human being holds a piece of real estate and they bought it for 100,000 and they put $20,000 down and they borrowed $80,000, they are able to depreciate the full $100,000. They get the full write-off on that 100,000, and that’s a big reason for buying the real estate. A lot of people want those write-offs that come with real estate and get the tax free money called rent.
If we play that exact same game inside of an S corporation, if the S corporation puts $20,000 down and it borrows the other 80,000, you’ve only got $20,000 as the basis for taking deductions. You’re actually limiting how much you can take in deductions and under certain cases, your ability to take the deductions disappears and it goes away. S corporations with rental real estate just make no sense because in many cases, what you’re doing is you’re limiting your ability to take your depreciation deductions on that real estate.
Matt: Got It. Good note. What else are the cons of holding an S corp, anything else?
Tim: Well, yeah, there’s a bunch of other reasons. Another big one is an S corporation is a corporation. If a corporation holds an appreciated asset, you bought that real estate inside the S corp for 100,000, freeway went in right next door, now it jumps up to 250,000 and now you want to do some other planning, some other configuration, so you move it out of the S corporation, moving to another partnership. That’s going to be considered a sale. Anytime you take appreciated assets out of a corporation, whether it’s a C corporation or an S corporation, you’re going to be hit with a sale, which is no win. Not very good. We don’t want that.
Matt: That’s right. We don’t. That’s how not to do it. Let’s get back to my question.
Tim: All right.
Matt: The one I wanted to ask.
Tim: You’re insisting that argument. All right.
Matt: What is the best way to do it? That’s going to be it depends, I’m sure, but-
Tim: It depends. I’m just doing the little Texas tap dance. They’re everywhere because there’s so many different ways you could do it. My preferred way of doing it is we put properties inside of a trust, and we can restructure that trust and have it taxed however we want to. With the trust, we’ve got asset protection. We can do tax savings. We can allocate the tax liability over to someone else.
If you’re making too much money, we started off talking about the physicians; they’re making too much money. Cool. Let’s allocate the tax liability over to their parents. Maybe their parents aren’t making much money. Let’s allocate it to the kids, the grandkids, whoever. There’s so many different ways we could do it. We can shift that liability over to somebody else or something else. Yet by having it wrapped up inside that trust, we’ve got asset protection as well where the bad guys can’t get it.
Finally, if we set up the trust properly, we can reprogram everything at a later date to change it all around based upon their situation. Whereas once again, if we have everything locked inside a corporation, whether it’s a C corporation or S corporation, we’re going to have all sorts of tax ramifications whenever we make any sort of change.
Matt: Got it. Why is a trust stronger than the “corporate veil?”
Tim: Why is the trust stronger than the corporate veil? Many times, the corporate veil is not nearly as strong as people think it’s going to be. There’s all sorts of different ways to wipe out the corporate veil. If the corporation wasn’t adequately capitalized, the bad guys can come riding in and say, “Hey, look, your honor. Under the corporation code, you have to have a lot of money. This corporation has to be capitalized, have capital inside there, and they didn’t do that.” This was a no-money-down transaction. Let’s wipe out the corporate veil. Boom, corporate veil disappears on something as simple as that.
A quick side note. Wyoming, everybody is talking about Wyoming LLCs because of wonderful things and everything. A couple of years back, the Supreme Court of Wyoming said, “Hey, look. This LLC, Wyoming LLC was established. It wasn’t properly capitalized. You guys lose all your asset protection.” They wrote a statute to offset that particular court case, but there’s all sorts of weirdness and quirks where the corporate veil can be wiped out fairly easily. Some stuff just happened with Nevada that got wiped out. There’s all sorts of weird things.
The cool thing about a trust, and it’s just incredibly simple, the cool thing about a trust is there’s no clear-cut owner to trust assets. A basic concept of asset protection is whatever rights you have in property, the bad guys can have those exact same rights. If you’re not the owner of the property but instead the trust is the owner of the property, and yet you’re the beneficiary getting the benefit of it and everything, there’s no clear-cut owner. Bad guys can’t take anything away. That’s the simple answer why the trust is a safer entity. There’s no clear-cut owner of the property, and bad guys step into your shoes for whatever rights you have. If you don’t have absolute rights in the property, they don’t have absolute rights and you’re protected.
Matt: If you are the beneficiary of the trust and you’re receiving the benefits of the property, don’t the bad guys have access to that?
Tim: Au contraire, no, because if you set up the trust properly, you make it so that you’re the beneficiary, but the trustee can tell you to pound sand anytime they want to. You don’t have a vested right, any right written in stone. You don’t have that ability to demand the trustee, give you the assets out. Now if you don’t have that right to demand for the assets to come out, bad guys don’t have that right. Nothing is written in stone and that’s why you want to have a trustee who’s somewhat favorable to you.
Matt: Got it. I always wanted this question. Who’s the best person to choose for your trustee?
Tim: Who’s the best person to choose for your trustee? Somebody you trust; hence the word trustee. Myself, I immediately jump over to, oh, I got a brother who I trust quite a bit. I would have my brother as the trustee. I’ve got a good friend who I trust quite a bit. It would be somebody who I trust quite a bit.
Let’s say my brother just really irritates me one day. He doesn’t buy me a nice Christmas present. Okay, cool. I can have the power to kick him out and bring in somebody else as my trustee. A lot of people say, well, what if there’s not that many people who I trust? To a certain extent, we don’t really care because there’s all sorts of controls written inside things were if they try to do something stupid, you can kick them out and move onto the next contestant.
Matt: Got It. The trustee, he controls the trust, but you can choose before and after who the trustee is.
Matt: Got It. Alright. That’s how you’re a little bit protected or you’re not totally [crosstalk 00:10:05].
Tim: It’s like a veto power. If someone has a veto power on your unfettered access to the assets then the bad guys, that same person is going to have the veto power on their unfettered access to the assets.
Matt: Got It. Cool. Another thing you said earlier, I want to circle back around to that, you said inside of the trust, you can start splitting, like you can give somebody a certain benefit of the property and somebody else gets another benefit based on their needs. I refer to them here as the for-profit centers of real estate. You’ve got the amortization, depreciation, the depreciation and the cash flow. In a trust, if you had a partnership, you can create that partnership with the trust and then assign those different things to different people.
Matt: Got it.
Tim: Once again, let’s say we assign them to certain people and two, three years later, the situation changes. Cool. No big deal. We can press a button and just totally reorganize the trust to change it the way that we want it to be changed to.
Matt: Got It. Cool. Like a scenario where you have a … Since we’re talking about doctors, you have a doctor who has a high income, right? He needs the tax deductions. You could go and partner with him on a property. You need the cash flow. He needs the tax deductions. You can keep the cash flow, the property. He gets all the depreciation to offset his pay. That would be an example.
Tim: An example. In theory, yes, there’s going to be some more complications with that. In theory, yes, that could work.
Matt: Got it. Cool.
Tim: You know, Matt, let me get on a soapbox for a second. This might irritate you. This might irritate your listeners, but I’ve got to say something. I’ve just got to say-
Matt: Thanks for the disclaimer. All right, here we go.
Tim: Let me talk about the disclaimer. Land trust. In my version of reality, land trusts are a four-letter word. They’re awful. They’re absolutely awful.
Matt: A-W-F-U-L, five letters, man.
Tim: I know. I didn’t graduate kindergarten either on math. I’ve got a client right now. They set up a land trust, and I said, “Why are you setting up a land trust?” He says, “Oh, it’s going to give me privacy on my actions.” It could if you set things up correctly.
Matt: Just to clarify, Tim. We went from trust to land trust. Is that the same conversation?
Tim: Thanks for saying, Matt. No, that was me just being a little bit jumbled on everything. A trust is basically a structure that has three parties. You have a grantor, the person who puts the assets into the trust. You have the trustee, the person who manages the assets. You got the beneficiary, the person that gets the benefit of the assets. That’s a trust.
That category could cover 10 million different variations. One of the variations out there … By the way, whenever I talk about a trust, I’m talking about an irrevocable trust, one that can’t be changed, but it is changeable, if that makes any sense. Just bear with me on that one. Just accept that fact. These people set up these things called land trusts, and typically what a land trust is, is I have a piece of property. I put it inside of a trust. I typically appoint someone else as the trustee and the beneficiary, and the trust is fully revocable. I can change it around anytime I want to.
Well, if I have the right to revoke that trust, the bad guys have that exact same right. They can revoke the trust as well. Whatever rights I have, the bad guys have the same rights. Land trust don’t give asset protection. The typical land trust doesn’t. Somebody might have a variation that does, but if it’s a revocable trust and you have the right to revoke it, you have the right to order the trustee to revoke it, there’s not going to be asset protection.
Other thing is they say, “Okay, these land trusts are great for privacy.” They could be good for privacy, but the challenge I have right now is one client that I have, they went out and bought a bunch of properties. Their attorney set up this land trust for him that was going to solve the world’s problems, and they named the client as the trustee of the trust. Now at the County Recorder’s Office, the owner of the property says, “Tim Berry, trustee of the Tim Berry Land Trust.” Where’s my privacy? I have no privacy. The whole world knows who’s the owner of this property or who’s tied with it.
The other aspect on the privacy is deeds of trust are typically recorded. If somebody is intelligent, the lender is intelligent, they’re going to have their deed of trust that you signed at the bottom recorded. If somebody is going to go to the County Recorder’s Office and try to figure out who’s the owner of a property, and they see it’s owned by the 123 trust and yet two weeks beforehand, there is a deed of trust that Tim Berry signed. They don’t have to be a mental giant to figure out Tim Berry is going to be getting some benefit somewhere along the line there. Personally, I’m not a big believer in these land trusts. A lot of people are, but I’m not.
Matt: You can step down now.
Tim: I’ve done [crosstalk 00:15:19] thoughts for the day.
Matt: We might as well just keep talking because there’s something that I have a question related to this.
Matt: That’s a common strategy, not exactly what you said, but it is a common tool used for a strategy of taking a property over subject to the existing financing.
Tim: Correct. That does nothing to avoid the-
Matt: The due on sale.
Tim: … the sale clause. It does nothing to avoid it. Everybody is out there saying, oh, it does, but it doesn’t.
Matt: Right. Totally. In fact, I’ve seen due on sale clauses that even think about assigning your property that’s in violation of it, right?
Matt: I don’t know how they prove your thoughts, but even if you thought about it, it’s in there. What it does is it does create that anonymity, and the bank isn’t quite aware that it has changed hands.
Tim: It can work great for that. I can’t use that fancy word. I can’t pronounce it, Matt. If you’re looking for it, what was that fancy word again?
Matt: Due on sale?
Tim: No. Certain words I can’t pronounce. Anonymity.
Tim: There you go. Privacy. Let’s just say privacy. If you’re looking for the privacy and you’re not listed as the trustee, it can work great. That can work good. I’ve done that many times myself. I’ve taken over the property. The person, let’s call it, it was the Fishers, and I said this is the Fishers’ living trust. I didn’t call it the XYZ land trust. I didn’t call it the 123 Main Street trust because that’s silly. No regular human being does that. I named it after them, and I made it their living trust because everyone is used to seeing a living trust. Quite honestly too, I don’t know if I should even tell you this, but I’m rambling, Matt. Just bear with me.
I actually named the people who I took the property from as the trustees because now under all the various regulations of California, the liability would run to the trustee if there is anything weird. These people would end up with a liability and not me also. There can be some effective uses of the land trust. It’s just 90 percent of the people don’t use them effectively or correctly.
Matt: Got It. Just to clarify. What we might have been discussing might sound playing in the gray area of the law. There is nothing illegal about taking over a property subject to the existing financing.
Tim: Absolutely nothing illegal with it. Done all the time.
Matt: Just want to clarify it because people like to say that’s illegal and is like, you must be a realtor. Realtors think everything is illegal.
Tim: Unless they’re doing it because there’s some realtors, they’re doing some crazy stuff as it is.
Matt: Perfect. All right. Well, that was a good show. We went down a couple of different avenues there.
Tim: That’s good.
Matt: Let’s do it again next week. All right?
Tim: Sounds great, sir. Appreciate it.
Matt: Sweet. All right. You can go to taxhacker.com. You can download Tim’s free book, How to Take Advantage of Five Loopholes and Trump’s New Tax Plan the Mainstream Media Isn’t Sharing with You and it could cost you a small or large fortune. It’s made its rounds of this new tax plan, but it hasn’t even gone … It’s into effect this year, so they really need … If you don’t know about it, you need to know about it now, right?
Tim: Absolutely, because there’s a lot of big savings out there for people and people are throwing away money if they don’t utilize it properly.
Matt: That’s a real thing. Even though a lot of things get blown out of proportion, he does so many weird things all the time that you forget about the last thing he did, but this is the real deal. This really can impact each and every one of you, so you can go to taxhacker.com to get a copy of that. After you’ve done that, you’ll have the opportunity to schedule some time with Tim, and either he or one of his team members will get on the phone with you for a short five to 10 minute call to assess your situation. If there’s a good fit, they’ll go ahead and they’ll take the next step and schedule a tax action plan for you. If there’s not a good fit, they’ll go ahead and they’ll share some alternative resources to where a better fit for you can be made.
Either way, Tim and his team are committed that you are better off after the call than you were before. To take advantage of that, you can go to taxhacker.com. Tim, any last bit of advice?
Tim: None that I can think of right now.
Matt: That’s it for Tim and myself. We’ll see you next week for another episode of Tax Hacker Tuesday on the Epic Real Estate Investing Show.
Speaker 1: That’s it for today as we dream of a tax system that works just for you, but until then, you have Tim Berry. See you next Tuesday for another episode of Tax Hacker Tuesday.