I was in Orlando, Florida a couple of weeks ago speaking to 1,400 people at the Rich Dad Annual Forum. During my presentation, I mentioned a prospective client whose entity structure was likely to cost him over $200,000 in taxes if all he did was refinance his real estate. One of the participants later asked for clarification about how an entity structure could make this big of a difference. Here is the explanation:
The prospect, we'll call him Mario, had arranged his affairs so that he had an S corporation that owned three LLC's. In one LLC, he conducted his architectural business. In the other two, he held investment real estate – single family homes.
I asked Mario if he ever planned on refinancing the homes. He said yes and that he was about to do so and had about $1 million of equity in the homes. He also indicated that he would have to re-title the real estate into his own name in order to do the refinancing.
Here is the issue. When he re-titles the real estate to his name, the IRS will treat this as though he sold the real estate to himself out of the S corporation at fair market value. So, he will have to recognize AND PAY TAX on the $1 million of gain, even though he is just refinancing the property and putting it back into the LLCs. The result is at least $200,000 of tax that he would not have paid had he used a better entity structure.
When we create tax strategies for our clients at ProVision, we examine ALL of the tax consequences of the entity structure. Be sure your tax strategist is doing the same for you and does not make a mistake like Mario's did with him.