On November 6th, 2010, the Realty Investment Club of Houston which is commonly (but not always fairly) referred as the RICH club had a celebrity guest speaker, Dyches Boddiford. From his vast experience as an investor and teacher, Dyches talked about structuring real estate businesses for asset protection and tax benefits.
Every time somebody talks about tax strategies and business entities, I receive a bunch of calls and emails: Michael, did you hear what Mr. Big said about this? Do you agree with him? All too often, I do not agree. Many experienced investors give tax and legal advice based on what they think to be the rules, not the actual rules. Mr. Boddiford, however, is a notable exception. His understanding of taxes is exceptional, and, although not a lawyer myself, I have to presume Dyches is equally strong in legal matters.
Does it mean that I agree with what Dyches said during that Saturday presentation? Absolutely! In fact, my What Is The Best Entity for Real Estate article mirrors a lot of points made by Dyches.
However, let’s get on the same page as far as what he actually did and did not say. Somehow, quite a few people sitting in the same room where I was sitting, heard things differently. So, let the game begin: did Mr. Boddiford really say this?
Dyches said: Flipping properties is a bad business.
He did not say this. Dyches observed that, among the many flippers he has known, nobody got wealthy from it. Flipping is effective in raising short-term cash, but in the long run, investors get wealthy by buying and holding.
I’m a tax guy, not a real estate guru. Accordingly, my opinion on the matter has little weight. However, having seen the financial results of hundreds of my real estate investor clients, I concur.
Dyches said: Every investor must establish asset protection plan.
Yes, kind of. But with a very important disclaimer that he mentioned very briefly, so it was easy to miss. You need to have assets to protect, first. This means that a beginner investor should NOT start with structuring his business. Instead, he should go out and make some deals and some money. The right time to structure his real estate business is after, not before, he acquired some properties or generated some cash profits.
Dyches said: The best asset protection is creating corporations and LLCs.
No, he did not say this. Despite the laughter in the room, Dyches’s statement was quite serious: The best asset protection is keeping your mouth shut. Then, you should have adequate insurance. And only after that do we talk about creating business entities. I cannot agree more.
Dyches said: Creating business entities is easy.
Yes, he did. But he immediately added that running them correctly is NOT easy. Most investors who create corporations and LLCs neglect the formalities, commingle money, or both. When the stuff hits the fan, this relaxed attitude will backfire in a big way. For some basic tips, check my I formed a company! Now what? article.
Signing up at the gym is easy. Going there regularly is not. But membership dues alone do not reduce your weight; they only reduce your bank account. Yes, I’m speaking from experience.
Dyches said: S-Corporations avoid Self-Employment tax for dealers.
No, they do not, and Dyches did not say so. However, the tax strategy that he was describing is rather complex, and it was easy to misunderstand. Self-Employment tax is a combination of Social Security tax and Medicare tax. S-Corporations can reduce but not eliminate the self-employment tax. The strategy involves paying yourself a modest salary. The salary does not escape the Social Security/Medicare tax, but everything above this salary does.
As with most tax strategies, it sounds simpler than it is. You will need to establish a formal payroll system, including paychecks, tax withholdings, and quarterly reports to the IRS and to the Texas Workforce Commission, plus a few other formalities. Simply transferring money to your personal account once a month will not do. Also, the size of your salary must satisfy the IRS guidelines. The game is worth playing, but some effort is required to play it right.
Dyches said: S-Corporations are better than LLCs.
Not at all! But somehow, more than one person got this impression from the presentation. Dyches recommended S-Corporations for dealers, including flippers and rehabbers, and he recommended LLCs for landlords. I have always used this same rule of thumb, too: just see my What Is The Best Entity for Real Estate article. Of course, any rule of thumb, including this one, cannot be blindly applied across the board.
Dyches said: Land Trusts are excellent tools for asset protection.
Wrong again! He said they were excellent tools – but NOT for asset protection. Land trusts provide zero asset protection. They are anonymity tools. Land trusts make it more difficult to find you, but they do not protect you once you’re found. Are they useful for asset protection? Yes, but only in combination with other structures, usually LLCs.
Dyches did not mention that Land Trusts are quite handy in structuring certain real estate deals. Their convenience for transferring ownership is often the main reason they’re used, however they still donot provide asset protection.
Dyches said: Self-Directed IRAs are not suitable for flipping.
Not quite what he said. Dyches spoke against the extra tax, known as UBIT, which is created when you do flipping inside a self-directed IRA. As an alternative, he described a creative strategy where the IRA finances the deal as opposed to directly buying and selling the property. If you’re considering flipping within your IRA, it sure makes sense to explore these advanced strategies.
Dyches said: He is against check-control LLCs inside Self-Directed IRAs.
Not really. Dyches is against the setup when the IRA owner is also the manager of the LLC. Such arrangements most likely violate the IRS rules about prohibited transactions, and there are easy and safe alternatives. Your IRA custodian should be able to guide you in this area.
Any other “Dyches said” questions? I’ll gladly answer, even if he did not. Or, if you prefer, you can contact Mr. Boddiford directly.