Celebrity Deathmatch - Posted by JHyre in Ohio
Posted by JHyre in Ohio on April 01, 1999 at 07:13:15:
This post is actually in answer to several posts & e-mails, public and private, re the best structure for holding passive rental properties. Two views seem to dominate the field- Bronchick’s and Kiyosaki’s. In one corner, we have Bill Bronchick. OK, he looks like he’s in high school. Don’t let the disguise fool you. He knows his stuff. Bronchick opines that passive property should be held in LLC’s/S-corps. In the other corner is Robert Kiyosaki. Qualifications: Been there, done that, the dude’s loaded. He likes corps in general (although NOT necessarily for passive investments!). What to do? What DOOOO you do, Kianu?
My free (take it for what it’s worth- it’s for educational purposes only, get a lawyer, don’t sue me, yada yada yada) opinion: For most of us, the pass-through entity is the way to go with income-producing properties held over time. Wait, is this blasphemy? Is an icon being maligned?
No (Yes, I know, very Joe Kaiserish sentence structure. Just don’t tell JTR).
Kiyosaki’s structure undoubtedly works for him. Once your worth some 7-figure+ sum, it may work for you. Chances are that the transaction costs that go with that structure do not make sense for holding passive investments at your current stage in life. To wit: Corporations- especially large ones that need to generate very creative deductions to keep income low- are maintenance-heavy. First off, there’s the Personal Holding Company issue discussed in a recent post. For those of you that missed it, PHC rules say that if corp is 50% owned by 5 or fewer people AND has 60%+ passive income, govt pretends you distributed that income AND pretends that you are in the highest (40%) federal income tax bracket. Sick fantasy. Kiyo has advisors to navigate around PHC rules. Expensive advisors. $400+/hour advisors. People who’ve been doing tax stuff as long as I’ve been sucking in air. My guess is that most of us aren’t at the stage where we pay too many people that much for too long.
But this is just the beginning. Corps are also subject to related party rules. That is, if two or more corps are 50% by five or fewer people (GROSS simplification) they are related. Easy to get around? Did I mention that the govt (for the People, by the People) pretends that you and most of your relatives and any entity that you/they own are the SAME person. By the way, if the corps are related, govt may apply the 15% $50k bracket as if all the corps were one corp. Ouch. Welcome to 35% corporate bracket (including “recapture” of 15% bracket) plus taxes on distributed income (remember, they may pretend distribution has occurred…).
Wait, I’ll just transfer excess income to other corps in the form of “consulting fees”. If I have some REALLY good friends, we can set up corps and play a shell game with consulting fees being the ball. Enter the common law rules of “economic substance over form”. If the fees are contrived, they are ignored or worse. Bottom line- the govt gets to pretend, YOU don’t. Can these rules be gotten around? Sure, for a price, including paying the advisor to discover ALL of your unique facts and circumstances…by now you get my point. Corps require lots of maintenance. You must decide whether the maintenance is worth the price. At some point, it is. When it comes to passive properties (as opposed to FLIPS!), the benefit gained- if any- is probably not worth the transaction costs for most of us at our current stage of development.
By the way, do not misinterpret Kiyosaki: The rich are NOT favored under the tax laws. Corporations are NOT necessarily favored under the tax laws, although they used to be. The Rich are targeted by tons of phaseouts and nasty rules. When Kiyosaki was learning from Rich Dad, high-bracket people were taxed at 90% rates (and we were the FREE world…). Corporations, however, had MASSIVE loopholes, so those with the resources and incentives to use them (the Rich) paid few or no taxes. From 1956 on, corps and other tax shelters have been squeezed HARD. In particular, I mean the Double-Cross (err…Tax Reform Act) of 1986. In 1986, loopholes were exchanged for low tax rates. Once the exchange was done, Congress and the Bush-Clinton Administration (that word is intentionally singular, for those of you that care) raised the rates. Are the rich favored nowadays? No, they just have the resources to be less screed- big difference. And getting screed less is getting more expensive all the time, thanks to those wonderful people in DC. My point- toys of the Rich (corporations in particular) are NOT automatic solutions to ANY problem. I’ve noticed a mind set in some quarters that they are some sort of magical elixir against taxes- nothing could be further from the truth. Corporations are effective in certain situations IF properly crafted. They are generally a lousy choice to hold passive investments.
And don’t get any ideas from the Rolex example given at the convention. Maybe there’s a trick I missed- I doubt it. That Rolex IS income to the recipient. Let me repeat: IF THE CORP GIVES YOU SOMETHING, THAT SOMETHING IS INCOME TO YOU UNLESS ONE OF A VERY FEW EXCEPTIONS APPLIES. Similar strategies are NOT for the faint of heart. Be prepared to pay those advisors LOTS on audit. Similarly, Nevada Corps are not usually a good idea if you don’t live in Nevada. There’s a reason that NV (and Cayman Island) corps attract special attention from the IRS.
I digress. I agree with the Bronchick approach- use pass-through entities for passive investments- corps offer few advantages and numerous pitfalls for such investments. Corps are MUCH more useful for flipping and reinvesting at HIGH rates of return. They still have the some of the same problems and expenses described above, but at least you’ve got something to gain in exchange for the complexity and expense.