Contributing real property to LLC for rental

[rjo1993]

My Fiancée and I own a condo that has been our primary residence until February of this year. We formed an LLC (taxed as partnership) and transferred title of the property to the LLC. It is now tenant-occupied. The mortgage is still in both of our names. We have been paying the mortgage and HOA with rental income, and we spent around $3,000 of our own money to renovate prior to renting the property and an additional $1,000 on plumbing after renting it out before our business debit card was set up.

We have a few general questions:

• Can we deduct mortgage interest, taxes, and insurance costs that are paid through the mortgage if the LLC does not assume the mortgage?
• Will there be any individual tax due from contributing property to the LLC that is subject to a mortgage?
• Can we reimburse ourselves for the startup costs and plumbing? If so, should we just issue an invoice to the LLC for those costs?
• The property has appreciated significantly since we purchased it, from $140,000 to $370,000. Does our initial basis carryover?

[M-MTax]

Transferring title to an LLC from both of you defaults to a partnership. You should see a tax pro as well as a lawyer who practices real estate and taxation in your area.

[CuriousDom]

What state do you live in? There may be a real estate transfer tax issue. A few states do not have it (e.g. ID, TX, etc.), and it may not be applicable to your situation based on the state statute. Do a quick search online to find out. Also, once you're married and filing jointly, in a community property state, you both possibly will be considered as a single tax payer, so the LLC will become disregarded.

You will likely lose the primary residence exclusion of $250k since it's now a business property and owned by the LLC. You may run into a tactic that asks you to sell the property to the LLC in an arm's length transaction to take advantage of the exclusion and get a step-up basis in the property. I personally would not follow this tactic unless you want to be the guinea pig. I don't believe there has been a case law to prove that this strategy would or would not work. But if the motive is to avoid tax, the transaction would more likely than not be disregarded by the IRS. 

The holding period and basis will carry over to the partnership. Record keeping is key, so make sure the value of the property and when it was purchased are stated in the LLC property agreement under contribution section. 

The contribution of property to the LLC is a nonrecognition event meaning it is not taxable. 

I assume you already created a separate bank account for the LLC and have been paying for all expenses through this account. Then you should be able to deduct these expenses on Form 8825. 

To avoid being pierced through the corporate veil, I would not try reimbursing yourself for the expenses paid to improve the property. I would capitalize aka add the cost of the $3k renovation to the basis of the property (unless it can be broken out into smaller pieces) and depreciate. The de minimis safe harbor threshold to expense is $2,500. You can immediately expense the $1k plumbing cost. Make sure to make the de minimis safe harbor election on your Form 1065 tax return. It is an election statement.

Further thoughts. I would try to have the LLC assume the mortgage as well. You want to be as clean as possible with these transactions between you and the LLC. If you don't respect the LLC as a separate living entity, why would the court or anyone else? Have you thought about forming a holding company in WY or NV for anonymity and asset protection? I'd recommend "The next level asset protection" book by Clint Coons.

Hopefully these points are helpful. As always, consult a professional before moving forward.