Legal Question in Real Estate Law in Pennsylvania

Re: Tax evasion in real estate

I believe what he is referring to is getting to a point where he will be treated as a dealer instead of an investor. The result would be that the money earned on these flips would be treated as ordinary income instead of capital gains. He would be required to pay tax at the higher ordinary income tax rates. IRS would probably treat your father-in-law and sister-in-law a new partnership. Don't really know, without more facts if it illegal. Sounds like your father-in-law simply needs better legal advice. He and your sister-in-law, brother-in-law should form a new venture (limited partnership, LLC) to acquire the proposed homes, he can be on the hook for the expenses and they can split the profits any way they like (provided they don't organize as an s-corp. Nothing illegal about it.

Re: Tax evasion in real estate

I suggest you consult legal counsel. In the event the mortgage is not paid the credit of the borrower will be destroyed and their personal assets will be at risk. Banks will require personal guarantees regardless if an LLC is involved.

Re: Tax evasion in real estate

You asked about how to deal with a proposed investment scheme in order to avoid certain tax treatment.

To my knowledge there is no limit regarding house "flips." Here I'll assume that the business seeks to be treated as an investor rather than as a dealer to avoid unfavorable tax treatment. Any scheme designed to avoid taxes is questionable though that does not in and of itself make it illegal. The IRS may look into the matter and if it finds that a party was not an actual participant in the business that the scheme to avoid taxes is illegal. In that case there could be potential civil and criminal penalties.

The better question to ask is how to go about the transactions legally? There are a number of ways and they all require active participation either through investment or through management. Simply acting as what is called a "straw man" is a often a surefire way to get into trouble. There are circumstances where a straw man transaction is perfectly legitimate, but I would suggest to only do so on the advice of a lawyer, trusted financial advisor, or investment expert.

Finally there is the issue of getting into such a business in the manner you describe. By personally entering the business, as an individual, the party is placing their entire asset base at risk. It would seem that the manager seeks to leverage the good credit of the party. This should raise all sort of red flags. Banks lend money based on credit worthiness. Banks are eager to lend money. If a bank won't lend money then what is it about the business that causes the bank concern?

I am impressed that you have the sense to question the transaction. You should urge all the parties involved to get competent advice. If the father-in-law refuses to let disinterested independent advisors be involved (i.e. not his people) then you have your answer that the practice is questionable.

Regards,

Roger Traversa