Hi, I have two residential rental properties in an LLC that I created, primarily for liability protection. One of the properties is generating passive income, and the other one is generating passive losses ie. rent is less than the expenses, depreciation, etc.
My question is - since both properties are under one LLC, can I use the losses from one property to offset the gains in the other when I file my taxes? I live in California, where both properties are as well. Thanks!
Balance/offset should be automatic and reflected on your Schedule E, with only the net gain/loss transferring to your 1040.
For tax purposes, the LLC is a "pass thru entity". The rental activity is reported on schedule E, the same as if the LLC didn't exist
Since rental income/expenses are passive, it gets reported on SCH E *no* *matter* *what*.
So if you have a single member LLC, absolutely nothing concerning the rentals will be reported on SCH C. Not one penny of anything. It all gets reported on SCH E.
If it's a multi-member LLC then the business is filing a 1065 Partnership Return. Still doesn't change the fact that the rentals are reported on SCH E as a part of the 1065 return. Then the partnership will issue each owner a K-1. That K-1 will be entered into each owner's personal 1040 tax return and gets reported on page 2 of the SCH E that is a part of their personal 1040 tax returns.
So if you have a single member LLC, you wasted a lot of time and money unfortunately. Here's some more potential for issues you may have down the road that make "liability" an afterthought.
Additional Information For Rental Property Owners
Occasionally a rental property owner will be “convinced” they need to put their rental property into an LLC (be it single owner or multi-owner LLC) as a means of protecting themselves and their personal assets from legal litigation should they ever be sued by a tenant. The property owner is told the LLC gives them and their personal assets a “veil of protection” from any legal litigation that may arise as the result of legal actions perpetrated by a rental tenant. Nothing could be farther from the truth. If you check court records (even in your local area) you’ll probably find numerous cases where a tenant sued their landlord and the LLC provided practically no protection of the property owner’s assets. That “veil of protection” supposedly offered by an LLC is so thin, even a new first time lawyer has no problem piercing that veil and attacking the personal assets of the property owner on behalf of the tenant. In fact, most legal firms will give these cases to their newest lawyers for esteem building, since they're easy to beat. There are other problems and issues with this too.
In order to legally transfer ownership of rental property to an LLC, the owner must have the permission of the mortgage holder. No lender in their right mind will give this permission either. Even if you think you can refinance the property or “sell” it to your LLC, unless your LLC has the cash on hand to pay for it in full, your LLC will never qualify for the mortgage loan. The lender doesn’t want to risk your LLC going under (by filing bankruptcy for example), and they lose money because of it. So I’m confident in telling you, that’s not going to happen.
When you create an LLC for your rental property, it’s generally understood that business income gets reported on SCH C as a part of your personal tax return. However, a SCH C business produces “earned” income, and a rental property produces “passive” income. What’s the difference?
Earned income is income which you have to do out and “do something” in order to earn it. This income is subject to regular income tax, and also an additional 12.6% self-employment tax. The SE tax is basically the employer side of your social security and Medicare. But rental income is not “earned” income, and therefore is not reported on SCH C. So if you create an LLC for your rental property, then absolutely nothing concerning that rental property will be reported on SCH C. Not one penny of rental income and not one penny of rental expenses.
Rental income is “passive”. That’s because all you do with rental property on a recurring basis is just “sit there” and collect the rent every month. You are not “doing anything” to “earn” it on a recurring basis. That’s why rental income is reported on SCH E. Rental income is subject to regular tax, but is NOT subject to the additional self-employment tax. This means that rental income DOES NOT COUNT for your social security account or Medicare contributions.
SO if you create an LLC for your rental property, there are two things that will NOT happen.
- You will not be able to “legally” transfer ownership of the property from you, to the LLC unless you have a really dumb lender.
- You will not report one penny of rental income or one penny of rental expense on SCH C.
So in the end, you will be filing a zero income/expense SCH C with your personal tax return.
Now let’s say you decide to file the 8832 to treat your LLC like an S-Corp, and then you transfer ownership of the property to your LLC. You can and will report your rental income on SCH E as a part of the 1120-S Corporate Return, and you will also report the K-1 on SCH E as a part of your personal tax return. But keep in mind that this is for ***TAX PURPOSES ONLY!!!****. So if a tenant sues you, I seriously doubt the courts will recognize your S-Corp, and I seriously doubt the court will recognize the S-Corp as a physically separate owner of the property. Remember, that 8832 Entity Classification Election is for “TAX PURPOSES ONY”. It has no weight at all for any and all other legal purposes – such as you being sued by a tenant.
SO if you want to do this (and it still makes no financial sense) then form an actual S-Corp and transfer ownership of the property to the S-Corp. More than likely the lender won’t allow the transfer. But you can sell the property to the S-Corp if the S-Corp can qualify for a mortgage loan. Overall though, it’s still financially dumb to do this. Here’s why I say that.
When you move out of your primary residence and convert it to residential rental real estate, you have to convert your homeowner’s insurance policy to a rental dwelling policy. Or if you buy the real estate as rental property outright, then you have to obtain a rental dwelling policy at that time. A rental dwelling policy will, at a minimum, include $300,000 of liability coverage. For most that will suffice. But if the property is in certain areas of the country you may want more liability coverage. I have three rentals myself and have a total of $1,000,000 of liability on each. It cost me less than an additional $100 a year on the insurance for each property. So for me, it’s worth it. It’s also significantly cheaper not only in money, but in time spent dealing with corporate taxes and all that other additional paperwork crap.
One mistake I see quite often is that when an owner converts their primary residence or 2nd home to rental property, and they fail to update their insurance policy. This can bite when you have a claim. If the property is insured as your primary residence, but you are using it as rental property (which is other than it’s insured use) don’t be surprised when the insurance company denies your claim, and you can’t find any lawyers that will take your case. If it’s a case of you being sued by a tenant, then to be honest and put it bluntly, you’re screwed.
@remaven wrote:My question is - since both properties are under one LLC, can I use the losses from one property to offset the gains in the other when I file my taxes?
Yes, losses from passive activities and gains from passive activities are netted (i.e., they offset each other).
See https://www.irs.gov/publications/p925#en_US_2018_publink1000296645
yes. losses on one will offset the profits on the other. for tax reporting purposes, a single member LLC is disregarded. So all the reporting is done on schedule E. In addition, each property needs to be reported in its own column on schedule E The program will do the netting.