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LLC rental income

My wife and I formed an LLC during the 2016 tax year to manage the  rental income of  a condo we purchased. However, it seems that we should not report this income as business income but split it in schedule E. Is that correct. That is, in turbo tax treat is as rental income and not add schedule C businesses for each of our shares. Please confirm or correct.

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5 Replies

LLC rental income

If you and your wife are the only owners of the LLC, then its considered a pass thru for tax purpose.  That means any type of income earned by the LLC should be reported on your personal return based on the type of income.  So rental income and expense goes on your Sch E. Interest income would go on your Sch B etc.  No reporting as Sch C income unless the activity of the LLC was you or your wife providing some type of services or consulting to others for a fee.

LLC rental income

Hello, 

need a bit more clarity on this solution, yes the income from the LLC is considered passthrough. But if you have a multi-member LLC is non-community property state, such as NY. You need to submit a 1065. Is that correct ?

ColeenD3
Expert Alumni

LLC rental income

@ciquo

 

Yes. That is correct. While the information below pertains to husband and wife, it is true for any multi-member LLC.

 

A qualified joint venture, for purposes of this provision, includes only businesses that are owned and operated by spouses as co-owners, and not in the name of a state law entity (including a limited partnership or limited liability company) (See below).

 

 Note also that mere joint ownership of property that is not a trade or business does not qualify for the election. The spouses must share the items of income, gain, loss, deduction, and credit in accordance with each spouse's interest in the business. The meaning of “material participation” is the same as under the passive activity loss rules in section 469(h) and the corresponding regulations (see Publication 925, Passive Activity and At-Risk Rules). Note that, except as provided in section 469(c)(7), rental real estate income or loss generally is passive under section 469, even if the material participation rules are satisfied, and filing as a qualified joint venture will not alter the character of passive income or loss.

 

You mentioned that both you and your wife own the LLC. You must then elect to be treated as a Partnership or Corporation. You do not qualify as a Qualified Joint Venture unless you are in a community property state.

Carl
Level 15

LLC rental income

My wife and I formed an LLC

So that means it's a multi-member LLC and SCH C just does not exist for a multi-member LLC.  A multi-member LLC files a 1065 Partnership return. The SCH C exist *only* for a 1040 personal return.

For rental property, income/expenses is reported on SCH E *no* *matter* *what*. Therefore the partnership will include SCH E as a part of the 1065 partnership return.  Absolutely nothing (not one penny) concerning the rental property is reported on SCH C of any return.

Upon completing the 1065 Parntership return, that partnership will issue each partner a K-1 which each partner will need to complete their person 1040 tax return. When you enter the K-1 data into the personal version of Turbotax for your 1040 return, the data from the K-1 will be on page 2 of the SCH E with your 1040 personal return.

As stated earlier, the Partnership is just a pass-through entity that (in my opinion) is a waste of time and serves no purpose, legal or otherwise. It just creates additional paperwork and significantly increases the likelihood of human errors that could trigger an audit.

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, many legal firms will give such cases to their “new hires” right out of law school because it’s a great confidence builder for them since it’s practically a guaranteed win for the tenant. 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 15.3% 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.

 

 

LLC rental income


@ciquo wrote:

 But if you have a multi-member LLC is non-community property state, such as NY. You need to submit a 1065. Is that correct ?


You would file a Form 1065 and, as part of that return, along with the 1065 file Form 8825 to report the LLC's income and deductible expenses from rental real estate activities. 

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