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Level 7

Depreciation and earned income

I am wondering if I have a rental property owned in my single member LLC, can I use depreciation on the rental to negate the taxes on the ordinary earned income I get from my job?
1 Best answer

Accepted Solutions
Level 17

Depreciation and earned income

No, you are not correct.

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Maximum special allowance.

The maximum special allowance is:

  • $25,000 for single individuals and married individuals filing a joint return for the tax year,

  • $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and

  • $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified.

 

If your modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), you can deduct your loss up to the amount specified above. If your MAGI is more than $100,000 (more than $50,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your MAGI.

Generally, if your MAGI is $150,000 or more ($75,000 or more if you are married filing separately), there is no special allowance.

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Given what you've said here you could deduct losses of up to $25K on your income tax return.  Just to reiterate, this is not a credit against your income tax liability, it's a reduction of your taxable income.  The "tax effect" would depend on your marginal tax rate.

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15 Replies
Level 20

Depreciation and earned income

A single member LLC is a disregarded entity for income tax purposes so ALL your income & expenses are reported on the Sch E and you MUST depreciate the property ... it is a requirement NOT an option.

That said, depending on your total annual income, the loss on the Sch E will offset other income on the form 1040.
Level 7

Depreciation and earned income

Thanks for your reply! So to confirm, if my annual depreciation over 27.5 years is $8000 per year, and my federal income tax from an hourly job is $8000, I would owe no taxes? Over-simplification I know... But does that question make sense? Thank you again!
Level 17

Depreciation and earned income

"...if my annual depreciation over 27.5 years is $8000 per year, and my federal income tax from an hourly job is $8000, I would owe no taxes?"


NO. You're mixing your apples with your oranges. The depreciation is an expense that gets subtracted from your rental income, (along with other rental costs), to come to a net rental income or loss. The effect on your taxes is the amount of the rental income or loss times your marginal tax rate. For sake of argument, if you have a net rental loss of $8,000, (and can actually use that loss on your income tax return; that's a function of your gross income), and a marginal tax rate of 24%, that saves you $1,920 in taxes.

Level 20

Depreciation and earned income

Long term rental income is passive income. Long term rental expenses are also passive. Your passive expenses can only be deducted from passive income. Once that gets the taxable passive income to zero, that's it. Anything left over gets carried over to the next year. If the property has a mortgage on it, then it is *very* common for your carry over expenses to increase with each passing year. You can't realize your passive loss carry overs until the tax year you sell or otherwise dispose of the property. Therefore it is not at all common for rental property to actually produce taxable passive income year to year. 

Under no circumstances and with no exceptions will passive rental income/expenses be reported on SCH C. All rental income & expenses is reported on SCH E regardless of what type of return is being filed; be it a personal 1040 tax return or even a 1065 Multi-member LLC/Partnership return. 

Please read the below to educate yourself on the possible nightmare (from which you will never awaken) you can find yourself in, if you report long term rental income on anything other than SCH E, not to mention the non-tax related legal problems you can (and most likely will) create for yourself by putting rental property into a single member LLC.

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. 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.

 

Level 7

Depreciation and earned income

Wow! Thanks for all the info! So from what I can tell, schedule C losses can offset ordinary earned income from a job. But anything to do with a rental income goes on a schedule E and that can never ever effect anything like wages from a job?

So if I pay like $7,000 in federal taxes in my job, owning rental properties can never benefit that realm of my life? :(

So... It is beneficial in its own right because you essentially never pay any taxes on the rental income? But it can't ever help you on 1040 Ordinary Earned Income?

Thank you for all of your replies!!
Highlighted
Level 20

Depreciation and earned income


@Jaredhaxton wrote:
So if I pay like $7,000 in federal taxes in my job, owning rental properties can never benefit that realm of my life? :(

Read the material at the link below about the special allowance.

 

https://www.irs.gov/publications/p527#en_US_2018_publink1000219124

Level 7

Depreciation and earned income

Aha. The picture is becoming clearer now. I really appreciate all of the input! Sounds like the only time you can use a rental loss against wages is if you are single. I'm married and file MFS.

So to sum it up, I'm married and have job that earns $60k-$70k on which I pay a good deal of income tax on. Having a rental property will never have any effect on the taxes I pay on the ordinary earned income... Absolutely correct?
Level 17

Depreciation and earned income

No, you are not correct.

----------------------------------------------------------------------------------------------------------------

Maximum special allowance.

The maximum special allowance is:

  • $25,000 for single individuals and married individuals filing a joint return for the tax year,

  • $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and

  • $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified.

 

If your modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), you can deduct your loss up to the amount specified above. If your MAGI is more than $100,000 (more than $50,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your MAGI.

Generally, if your MAGI is $150,000 or more ($75,000 or more if you are married filing separately), there is no special allowance.

----------------------------------------------------------------------------------------------------------------

 

Given what you've said here you could deduct losses of up to $25K on your income tax return.  Just to reiterate, this is not a credit against your income tax liability, it's a reduction of your taxable income.  The "tax effect" would depend on your marginal tax rate.

View solution in original post

Level 20

Depreciation and earned income


@TomYoung wrote:
  • $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and


True, but I am not sure we know whether the OP lived apart from his/her spouse at all times during the tax year.

Level 7

Depreciation and earned income

I live with my wife. The MFS is because of student loans and repayment plans... :( 

 

Knowing that, where does that put me in the grand scheme of things with this? Thank you so much! 

Level 20

Depreciation and earned income


@Jaredhaxton wrote:

I live with my wife. The MFS is because of student loans and repayment plans... :( 

 

Knowing that, where does that put me in the grand scheme of things with this? Thank you so much! 


I think the following statement from the IRS publication is pretty clear:

 

The special allowance isn’t available if you were married, lived with your spouse at any time during the year, and are filing a separate return.

Level 7

Depreciation and earned income

Yeah... pretty clear... haha. Ouch! Thank you so much! 

Level 17

Depreciation and earned income

I missed the "MFS" point.

Level 7

Depreciation and earned income

Here are my takeaways... Thank you to everyone who replied!

 

1. Putting a rental into an LLC is dumb and useless. Just increase liability insurance. It is cheap!

 

2. Find a fix for my wife's student loans so we can file jointly so we can reap the full benefits of owning rental. 

 

3. Schedule C income/losses and schedule E income/losses are completely different and never affect each other... if it weren't for the special allowance in specific cases that do not apply to me currently

 

4. TurboTax forums are awesome! Knowledgeable people actually willing to help the less-seasoned among us! Thank you everyone!