Categories
Flipping

How an S Corp Election Can Help Flippers

While house-flipping is potentially very profitable, there’s an expensive catch.

You might have to pay a self-employment tax, which is a whopping 15.3% of your profit. That’s a significant amount of money that can go to your next vacation or property you want to flip!

Nevertheless, there is a way to set up your business in such a way that you’re not required to pay the tax. Let’s take a look at how an S Corp election can help you pocket more of your flipping profits.

Why House Flipping is Subject to Self-Employment Tax

While the usual real estate investments such as buy-and-hold are considered a passive activity, flipping homes conducted in a limited liability company (LLC) are active transactions—required to pay self-employment tax on top of the income tax.

Let’s define these two things that come with flip-and-fix projects.

Active Income. Active income applies to anybody who runs a business where one earns ordinary income from performing a service or selling a product. Business owners must pay the 15.3% self-employment tax up to a net profit of $128,400. (Beyond this threshold, you’ll only pay 2.9% as the Social Security portion of the self-employment tax is removed.)

Self-employment Tax. In essence, self-employment tax is similar to payroll taxes withheld from an employee’s wages. For self-employed individuals like house flippers, however, they must cover both the employer and employee portion of the tax. In addition, members of an LLC taxed as a partnership are considered self-employed individuals—which means their earnings will be subject to self-employment tax if they participate in the partnership’s trade.

The 15.3% self-employment tax of your gross salary does chip away at every dollar you earn. Moreover, 15.3% comes in before including the marginal tax rate from the federal and state perspectives. For example:

So, naturally, we want to find a way to save on taxes. One way is to run your flip-and-fix business out of an S Corp instead of an LLC or C Corp. Let’s talk about how you can do this.

How an S Corp Election Can Save on Taxes

First, set up an LLC or C Corp, then elect to have it taxed as an S Corp. Said structure is a tax entity or federal tax election—not a legal one. It’s not for asset protection but for reducing your exposure to tax.

By conducting your business this way, self-employment taxes only apply to a “reasonable salary,” and you’ll pay the remainder of your income as a dividend—not subjected to self-employment taxes. 

Here’s how it’ll go: Set up the S Corp, set up payroll, and begin paying yourself a W2 wage. The self-employment tax will only apply to the W2 wage, and the rest of the income will be considered a cash distribution or cash dividend. Of course, you can only do this with an S Corp route.

Take a look at how the situation now changes and how much you can save:

If you earn $100k with no S Corp (either as a Sole Proprietorship or an LLC), you’ll report your income as Schedule C. You’re going to pay $15,300 on self-employment taxes even before the marginal tax rate or state taxes come into play.

However, if you’re taxed as an S Corp, you can pay $50k to yourself as a W2 wage and have the other half as a cash dividend. With the $100k split up, half of it won’t be subject to the 15.3% tax—and you can pocket $7,650 just like that.

Just remember to never pay yourself the entire profit in W2 Wages. The whole point of setting up an S Corp is to help you reduce taxable income!

Conclusion

There are so many other factors that will come into play, so make sure that you talk to your accountant before considering this tax election for your flipping business. You may be able to amend your LLC to take advantage of this technique or establish a new LLC to start conducting your business as S Corp from the get-go.

Either way, it’s a good strategy to save on taxes legally!

Image courtesy of Jopwell

What do you think of this technique? Any additional tips on how to save on taxes?

Categories
Landlords

How Landlords can Easily Raise Rents

Many landlords dread raising rents on their tenants for fear of the tenants moving, or the landlord just finds the whole process unpleasant. So, it’s not uncommon to find landlords that haven’t raised rents in 2, 3, or more years. 

Raising rent is actually a regular (albeit not the most fun) part of being a landlord. A landlord should raise rents as the market dictates, because: 

  • Keep up with inflation
  • Be able to afford rising maintenance costs
  • Accommodate property tax & insurance increases
  • When you’ve renovated a property to a higher standard

When that time inevitably comes, you need to know the right way of increasing your rent. Doing it the wrong way might cost you, tenants, leading to longer vacancy periods and costlier turnovers. Plus, no landlord wants to feel like the bad guy, so it’s important to show you’re being fair by handling rent increases diplomatically.

This article will teach how you can raise rent amounts and generate more income while communicating the situation professionally to your tenants. We’ve even included a sample rent increase notice that you can use for informing your tenants as amicably as possible. 

How should you approach a rent increase?

Depending on local and state laws, the required notice period for rent increases can range from 30 to 120 days. In Michigan, you have to give 30 days’ notice, but if you’re raising rent by 10% or more, you have to inform the tenant 60 days ahead of time.

Most people draft a letter informing tenants of the increase (like the one we’ve included below) and send it out to them, but there’s another way to approach this: 

  1. Go on Zillow, the MLS, or Rent-o-Meter to find what the market rent for this property is.
  2. Compare that to what the tenant is paying.
  3. Submit that information to the tenant and ask them what seems fair in terms of an increase

Note: At this point, you haven’t told them the rent was going up, but you’ve implied it. You’ve also involved them in the decision, so they’re more willing to accept it, making this a more subtle, non-aggressive approach to raising rent.

  1. The tenant’s response will typically be to offer 50% of the full increase, although some will say they don’t want to pay any increased rent at all. A good way to address either of these scenarios is to ask: “Why do you think that low of an amount is fair?” Make them defend it. 
  2. Then they’ll explain why they shouldn’t pay an increase (personal emergencies, poor maintenance on your part, etc.). Then you can ask: “Are you sure that’s your best offer?” 

The best part about this is that it lets you raise rents without TELLING the tenant there will be an increase, but rather including them in the process.

Tenants may even surprise you by offering more than what you expected! 

How much can you increase?

Ideally, you’ll want to keep the raise to less than 5% per year. Any higher, and your tenants will most likely move away—even if the rate is similar to your competitors in the market.

Why?

Think of the other rule of thumb that’s often used in screening tenants: rent amounts should only be a third of the tenant’s monthly income. This means most people can’t afford to spend an additional hundred dollars a month on rent payments – unless the tenant base in your area is on the up and up, like because of new employment opportunities or developments nearby.

Jacking up the amount too high without good reason will therefore jeopardize your rental income, as tenants will struggle to pay fully and on time. 

Plus, once a tenant has been there a while, they feel entitled to zero rent increases forever. If you raise it from $800 to $900 overnight, they’ll freak out. Even if the rent in the area is $1,100, they can’t afford it. So you’re better off with consistent smaller rent increases, like $25 a year, rather than waiting 3 years and increasing your rent all at once to reflect current market value.

On top of this, some cities have rent control laws in place. These maximum rent caps on what landlords can charge and are implemented by the government. Be aware of your local regulations before implementing any rent changes (just FYI, rent control isn’t allowed in the state of Michigan, but it is common in markets in New York and California).

Sample rent increase notice

When you’re ready to implement the raise, here’s a sample rent increase notice that Colleen F. shared in the BiggerPockets Forums. This letter is great because it helps tenants understand the landlord’s own financial obligations and view an increase in rent as a necessary business decision, rather than thinking you’re just being greedy.

Feel free to use it as a basis for crafting your own notice:

Dear John Tenant,

Thank you for being a tenant here at 123 Main St, Apt 1. Our goal is always to provide a nice place to live, at a fair price. Whenever the prospect of raising rent comes up at any property, we take a good hard look at it to make sure it’s necessary.

In that light, we have decided it is necessary to raise the monthly rent on your unit, effective September 1, 2020, to $1,050 from $1,000. This is partly to offset the increasing cost of property taxes, insurance, high heating expenses, maintenance costs, and upgrades since our purchase of the building in 2010.

Even after this increase, we believe we are still at or below the average market rent for a unit of this type. Rather than pay an increase, you may choose other housing. Should you intend to vacate at the termination of your lease, the original lease agreement states that you have to provide 30 days written notice of your intent to move. If you choose, signing this form checking off that you will not renew and returning the form to us 30 days in advance of your expected renewal will be considered your written notice.

Sincerely,

Management

Conclusion

There’s no guarantee that your tenants won’t complain about an increase in rent. However, if you increase your rent fairly and strategically, you can manage their expectations and prepare them ahead of time to budget appropriately. 

When they’re prepared and you communicate openly with them about the situation, your tenants won’t see you as the bad guy for increasing their rent. 

Any other concerns related to increasing rent amounts? Leave a comment below!

Categories
Landlords

How to Find Good Contractors for Your Rental Property

There are many shady contractors out there! Finding a trustworthy contractor to work on your rental property can be tough. You want to make sure that you find one who will do good quality work, is licensed, and won’t rip you off.

To ensure you get the best contractor for the job, here are 5 steps you should follow.

1. Gather Your Options

There are several places you can go to look for contractors that can serve your area:

  • Ask for referrals: Ask your friends, family, and colleagues who have had the same kind of work done for any recommendations. Many contractors rely on word-of-mouth advertising to build their client base and reputation, which makes it easy for landlords to ask around.
  • Read neighborhood review websites: Popular sites like Nextdoor give you several leads, all with contact information and recommendations for your area. You can also check Angie’s List (now Angi) or Yelp for more client reviews.
  • Post on social media or advertising sites: Posting on your social media platform may get you connections and recommendations from people outside your circles.
  • Ask hardware and supply centers: Your local hardware store or building supply center will likely have a list of plumbers, carpenters, electricians, and more. You can ask the customer service representative for their details. 

Our pro tip? Seek out the hustlers. Visit Home Depot at 6 AM on Saturday to find hard-working contractors. 

While others are sleeping in on the weekend, these hustlers will be wide awake and ready to work. You want contractors like this, who work beyond the usual 9-5 on weekdays, as your tenants are usually available for repairs only when they’re not at work themselves. You don’t want to pay contractors “overtime pay” for coming in on weekends! A good contractor will be greedy—grabbing opportunities to work even on odd hours, and some of them won’t even charge more for doing it. 

2. Research Them Online

If you’ve done your research, you’ll likely end up with a long list of contractors. Shorten your list by doing an initial sweep online—conduct your own background research for any shady activity or active disputes by certain contractors. 

Pull up Google and type in their name, their company’s name, and your city. Add keywords such as “scam,” “complaints,” or “court” to reveal negative information against the contractor.

3. Initial Interview

After the initial screening, choose the ones you’re comfortable with and schedule an interview. You’d want to ask questions about their services, such as:

  • How long have you been a contractor?
  • How long has the company been in business?
  • Is the team familiar with this kind of work before? How often?
  • Does the team have references that I could see?

Narrow it down to a handful of contractors. The next step will determine who’ll make the cut.

4. Verify with References

By this point, you’ve talked to the contractors themselves. This is the time to talk to the client references to verify service quality and performance.

Call former clients and ask the following:

  • Was the work done in a complete and timely manner?
  • Was the work done according to the agreement?
  • Was the contractor well-organized and professional?
  • Did the contractor charge fairly? Were there additional costs?

After this, you should have a shortlist of contractors that you want to proceed with. 

5. Screen Them Thoroughly

Schedule a meeting with each contractor to discuss the work in more detail. See how they feel about the proposal, and get a sense of their work ethic as well.

It’s important that they are experienced, knowledgeable, and officially licensed to carry out the work. Clearly outline your expectations, as you’ll be relying on them for both basic and emergency property maintenance.

The key questions you need to ask are:

  • When are you available and what locations do you serve?
  • What type of work would you say your team is most capable and skilled at doing?
  • Can you walk us through a typical job and the communication you provide?
  • How often do you send pictures and videos of the work? Are they clear and detailed?
  • What are your licenses and insurance to complete this particular project?
  • Can you pull permits, or would I have to?
  • How are your estimates and invoices created and delivered?
  • What is your preferred payment schedule?

Then, get into the details of how you want them to serve you by asking the following:

  • Will you add us as “Additionally insured”?
  • Will you agree to estimating and quoting by the job instead of hourly?
  • Will you allow payment within seven days to allow time for inspection?
  • Will you sign waivers for all payments?
  • Will you agree to a background check?
  • Will you sign a W-9?

Once you’re confident with a contractor, draw up the contract and close the deal. The document should include all the important information, including the start and end dates, payment schedule, materials required, description of the work, and specific instructions on how to handle any changes to the project plan.

Conclusion

With a good selection process, you’ll have a whole roster of trustworthy contractors in your arsenal, ready to meet the quality you expect from the best of contractors.

Gradually build your list of contractors you’re happy with, and keep their details easily accessible. You’ll never know when you’ll need to call them!

Image courtesy Tima Miroshnichenko

Categories
DIY

Landlords: Tenant-Proofing your Rental Properties

Tenant-proofing your rental properties is kind of like baby-proofing your house–it saves both of you from unnecessary headaches. The key when tenant-proofing is to identify the things that get abused the most, and think about how you can minimize damage to these areas, or eliminate them altogether. This is especially true for properties in low demographic neighborhoods, whereas problems like these rarely occur in higher-demographic areas.

Here are some other things you should avoid if you want to minimize the risk of extra damage costs:

  1. Avoid Garbage Disposal – Have you ever watched a movie, and the characters threaten to drop something meaningful into the garbage disposal by the sink? Yes, it’s true, people love to put all types of things down that drain. It’s handy–but also very easily clogged. It’s a piece of high-failure, time-consuming equipment to fix.
  1. Avoid Air-Conditioning Units – This may seem necessary, especially during the sweltering summers in Michigan, but AC units are not a requirement. Repairs are pricey and window-mounted models often disappear in the hands of thieves. Leave it to your tenants to buy one for themselves!
  1. Forbid Wall-Mounting – People like putting up decorations on their walls, but strictly avoid any nails or screws that put ugly holes in the walls. There are plenty of adhesive hooks in stores that tenants can use as an alternative, and walls with adhesive residue are easier to repair than those with holes. If you do allow nails, plan on deducting repair costs from the security deposit, because most tenants won’t repair the holes themselves (even if it says so in the lease).

Instead, install features that can help keep your rental properties clean and easy to maintain:

  1. Install Durable Flooring – Vinyl flooring is your best bet here, as it’s affordable, durable, simple to install, and it’s easy to remove any stains that a renter would leave. Although having carpet is a preference for some, it gets old and stained easily, with some stains refusing to come out at all, and absorbs odors from pets and smoke. Similarly, hardware floors – while a great feature to have when selling a house – can easily get scratched or damaged, and cost thousands to replace. With vinyl floors, all you need is a mop and bucket of soapy water, and you’re pretty much good to go. 
  1. Install Door Stoppers – Doors swing open and close multiple times a day, and many people (especially kids) won’t care if the doorknob puts an indent in the wall. Installing door stoppers is a must-have in rental properties, as it will save both your walls and your doors from unnecessary damage.

There are a surprising variety of door stoppers on the market, from baseboard stoppers and ones affixed to the back of the door itself, to wall-mounted handle stoppers and magnetic stoppers. One of the best options is the hinge pin stopper, since it has less chance of getting overworn through constant use (or played with by children).

  1. Install Window Coverings – Blinds, drapes, or curtains might seem like an added expense (and another thing to replace if damaged by a tenant), but it’s a good idea to install some kind of window covering to avoid giving thieves or squatters a clear view inside the property. Cheap coverings will do the trick, and if they’re damaged when the tenant moves out, you can deduct the replacement cost from their deposit.
  1. Opt for Durable Fittings – Some things, like faucets, can be bought as cheap plastic pieces, costing in the region of $40. While this may seem like a good cost savings in a lower-demographic rental, these cheaper fittings usually break down quickly and will need to be replaced every 2 years, on average. Investing in a more expensive, more durable option, like a $120 metal faucet, will mean that fittings can last for up to a decade before wearing out, saving you more money in the long run.
  1. Keep Pests Out – When doing property turnovers, consider conducting routine checks for pests and take preventative action, if necessary. Pests and insects hide well, and pest control services can add up to a fortune if the problem is left to worsen. So better to discover any potential infestations early, and fight back with rodent traps, chemical-free solutions, and an exhaustive scrub-down between rentals.

Follow these tips, and you should have a property that’s as tenant-proof as it’s possible to be. Of course, there will always be repairs and maintenance that need to be carried out at the end of every lease, but by planning properly, you can minimize the chance of incurring additional expenses for damages that could have been easily avoided.

Image Courtesy of: Ksenia Chernaya