If the LLC is a single-member LLC, it would be the same, for federal income tax purposes, as if you did not transfer the property to the LLC (clearly, there are other, non-tax, considerations and implications).
Otherwise, the transfer to an LLC is a contribution to capital and has virtually no tax impact. The LLC will take your basis (i.e., a carryover basis) in the property.
Transferring long term residential rental property to a single member LLC changes nothing. All rental income/expenses/depreciation continues to be reported on SCH E as a part of your personal 1040 tax return. Absolutely nothing concerning the rental is reported on SCH C.
Transfering to a multi-member LLC also changes nothing in the end. But you'll be reporting all rental income/expenses/depreciation on IRS Form 1065 - Partnership/Multimember LLC Return. The Multi_member LLC will then issue each partner/member a K-1 which is reported on each partner's 1040 tax return. The information from the K-1 will still end up on SCH E of the personal tax return, but just on page 2 of the SCH E. With a multi-member LLC this adds additional costs since you would have to purchase a physically separate program (TurboTax Business) to complete and file the 1065 Partnership return.
While the standard 1040 personal tax return is due Apr 15th, the 1065 Partnership return is due by March 15th. (Unless those days fall on a non-business day of course). Late filing penalties are high for the 1065 return. For 2023 the late filing penalty is $205 per month, per member. So if a partnership has 2 members and you file it one day late, a $410 late filing penalty is assessed.
If you have a mortgage on the rental property, changing ownership can present it own problems outside of taxes too.
The below is not to deter you from making a business the legal owner of your rental property. It's more to educate you so that you can make an informed and educated decision. Any decision you make should not be based only on the information provided here. You should seek legal advice not just from a tax professional, but from a "legal" professional knowledgeable in all the legal aspects outside of the tax ramifications of your decision.
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. Laws differ on this from state to state, so this may not be “entirely” true to the degree you may think it is. It can be easy for the business owner to unwittingly make a mistake that allows the legal piercing of that protection.
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 or other assets on hand to pay for it in full, your LLC may 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 while not impossible, the chances are 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 long-term rental property produces “passive” income. (the definition of a long term and short-term rental can differ not only from state to state, but from lower level taxing authorities within the state.) 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 form 8825 as a part of the 1120-S Corporate Return. Then the corporation issues each owner/member a K-1. Each owner/member enters the K-1 on their personal 1040 tax return, and the rental information ends up on page 2 of the SCH E as a part of your personal tax return. But keep in mind the S-Corp election for an LLC 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 to "protect my personal assets."
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.
Overall, if you're going to do this, you need to do it right. So seeking legal advise from a legal professional would not be a choice; it would be a must.
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