Tax Year Prior to 2020: My wife and i have two rental properties. We formed an LLC to manage these properties. How do I enter profit and loss for these two properties?

[mcaleer2002]

Is the answer below still valid for 2017 taxes? My wife and I live in Texas and formed and LLC midway through the year. I would prefer not having to figure out how to split between the 1040 and 1065 if I can disregard the entity.

[DS30]

It depends on the form and location of the LLC.

According to the IRS, if an LLC is owned by husband and wife in a non-community property state, the LLC should file as a partnership. LLCs owned by a husband and wife are not eligible to be "qualified joint ventures" (which can elect not be treated as partnerships) because they are state law entities.

If you are in a community property state ( Louisiana, Arizona, California, Texas, Washington, Idaho, Nevada, New Mexico, and Wisconsin), you have a choice.

If there is a qualified entity owned by a husband and wife as community property owners, and they treat the entity as a:

• Disregarded entity for federal tax purposes (a Schedule E filing for a rental property LLC), the Internal Revenue Service will accept the position that the entity is disregarded for federal tax purposes.
• Partnership for federal tax purposes (a Form 1065 filing), the Internal Revenue Service will accept the position that the entity is partnership for federal tax purposes.

A change in the reporting position will be treated for federal tax purposes as a conversion of the entity.

A business entity is a qualified entity if:

1. The business entity is wholly owned by a husband and wife as community property under the laws of a state, a foreign country, or possession of the United States;
2. No person other than one or both spouses would be considered an owner for federal tax purposes; and
3. The business entity is not treated as a corporation under IRC §310.7701-2.

For more information see Single Member Limited Liability Companies

If the LLC is treated as a disregarded entity for US federal income tax purposes, you will include the rental income and expenses on a Schedule E attached to your personal income tax return and you would report the rental activities for the entire 2016 tax year as if property was not transferred to an LLC. You do not need to indicate to the IRS that the rental property was transferred to the LLC and can still use your SSN on Schedule E when filing.

Once you have signed into your TurboTax Account (for TurboTax Online sign-in, click Here , then select "Take Me to My Return"), type "Schedule e" in the search bar then select "jump to Schedule e".

If the LLC is NOT treated as a disregarded entity for US federal income tax purposes, you will need to be reported on a separate federal income tax return (you will need TurboTax Business, you can purchase a downloadable copy here ) If reported as a partnership (Form 1065), you will need to include your K-1 from this partnership with your individual US federal income tax return. In this situation, you would only report your rental information on Schedule E up to the point when the rental property was transferred to the multi-member LLC. Then you would need to file a business return for the LLC based on your LLC's entity structure (Corp - 1120/1120S or Partnership - 1065).

[haiya408]

Thank you for the clear answer. I am in the same situation, I have two follow up questions:

1. Do I need to file anything with IRS to declare my LLC as disregarded entity?
2. If I treat my LLC as disregarded entity and file Schedule E, do I need to file any tax return for the LLC for California, such as Form 568?

[drdaddy_2]

We use schedule E and I don't know about a disregarded entity. We live in Texas which has no personal income tax and a business tax floor of 1.3 million. So there are no state taxes involved.

[TaxGuyBill]

@haiya408   Personally, I would still call it a Qualified Joint Venture on Schedule E.  However, that really won't change anything.

Yes, you would need to file the California LLC form, along with paying the $800 minimum fee.

[Katy]

In the non-community property state scenario using TT Business, how do we handle (enter) the basis and depreciation of the property.  My property was rental property (Schedule E) for almost 10 years before we changed it to an LLC.  The new Business version is starting over with the 27.5 year depreciation schedule, and no where to acknowledge the previously deducted depreciation.

[stevewhitson]

Hello Smart fellas,

I have a similar but slightly different situation. I live in Texas and have a Single Member LLC but have elected to use it as an S Corporation. I have one Single Family Rental that is a Subject To (The loan is someone else's name) but the House is Deed-ed to the LLC.

1. Can I just file Schedule E as if this was on my personal tax return, or do I need to use the Business tax and show the income expense on it and then create a K-1

2. If I do need to create a K-1 then, can I use the depreciation which turns most rentals into a loss and then use the K-1 to file the personal return?

Thank you!

[Critter]

1. Can I just file Schedule E as if this was on my personal tax return, or do I need to use the Business tax and show the income expense on it and then create a K-1

If you elected for the LLC to be taxed as an SCorp then you MUST file the 1120S ... and if you have not filed the 2018 return yet then it is VERY late as it was due 3/15/19 so file it ASAP.

2. If I do need to create a K-1 then, can I use the depreciation which turns most rentals into a loss and then use the K-1 to file the personal return?     

The 1120S will produce a K-1 that you enter on your personal return no matter what the bottom line is. 

[Carl]

Rental income and rental expenses are reported on SCH E no matter what.

If you formed a multi-member LLC/Partnership, then it's reported on SCH E as a part of the 1065 partnership return.

If you formed a single member LLC, then absolutely nothing concerning the rental will be reported on SCH C. Not one penny. It all gets reported on SCH E as a part of your personal 1040 tax return. If residental rental property is the only thing the LLC owns, then you will not be filing a SCH C at all, as there is nothing to report on SCH C.

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 2^nd 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.

[ekad4]

Ok we are not having a dumb lender since we have no lender at all - what if yo do not have a mortgage? How does this all square up?  

My husband and I are pondering to LLC or not LLC our beach property in Virginia - but I was wondering - what happens when we make an LLC owner of the house? Do we actually "sell" the house to the LLC for the sake of filing taxes? How would the depreciation deduction work in this case?  There is also a new wrinkle in the tax code that allows businesses a tax-free 20% pass-through from income but this is not possible with schedule E, you have to file either schedule C or something else...

[Critter]

Do not do an LLC for a rental ... it will NOT get you anything you don't already have and will just cause you to file another return for an extra cost.  BEFORE you do anything you really should have a sit down with a local tax pro to explain all the pros & cons. 

As for the new deduction ... even if you put the property in the LLC you may still not get the deduction ...

Can I get the QBI deduction on rental income?

Qualified business income, or QBI, is the net income generated by any qualified trade or business under Internal Revenue Code (IRC) § 162.

Rental properties are typically treated as passive activities, which are excluded from the definition of a qualified trade or business. However, rentals that qualify as trades or businesses under IRC § 162 are not considered passive, and that means their income can qualify for the QBI deduction.

To provide preliminary guidance to this popular question, the IRS recently released Notice 2019-07, the key points of which we've summarized below. We expect that IRS guidance will continue to evolve around this topic, and will provide updates when that occurs. Bookmark this page and check back often!

Exclusions

Income from these types of rentals is specifically excluded for the purposes of the QBI deduction:

• Passive rental activities that are not considered a trade or business
  • For example, a single-family dwelling rented out for a year or more in which there is little or no interaction between the landlord and the tenants other than periodically collecting rent and the occasional repair
• Property used as a residence by the taxpayer for any part of the year under IRC § 280A
  • This includes vacation homes, cabins, seasonal or "snowbird" residences, etc.
• Triple-Net (NNN) leases, where the tenant or lessee pays real estate taxes, insurance, and maintenance in addition to rent and utilities
• Rentals located outside the United States
• Land rentals

If your rental or rental activities fall into any of the above categories, you can't take the QBI deduction on the income.

Real Estate Professionals

If you’re a real estate professional for tax purposes (that is, over 50% of the personal services you performed in business during the tax year were in a real estate business you materially participated in for more than 750 hours that same year) then your rental income qualifies for the QBI deduction, provided all the other conditions are met.

Everybody Else

What if you own a rental – or three – but don’t qualify as a real estate professional? Turns out you can qualify for the QBI deduction, as long as your rental activities constitute a trade or business.

Generally, this means each rental real estate enterprise (a rental property or group of similar rental properties, including K-1 rental income) must satisfy these requirements:

1. Each enterprise has its own books and records to track income and expenses;
2. At least 250 hours of rental services are performed per year per enterprise; and
3. (Starting with tax year 2019) Contemporaneous records of services performed are kept which includes who performed the service, description of service, the date of the service, and how long it took (who, what, when, and how long).

Rental services can be performed by the owners or by their employees, independent contractors, or agents and would include things like:

• General operation, maintenance, and repair of the property
• Purchasing materials
• Property management activities
• Supervising employees and contractors
• Advertising the property for rent
• Tenant selection and background checks
• Negotiating and executing leases
• Collecting and depositing rent

Activities excluded from the definition of rental services include:

• Time spent traveling to and from the property
• Reviewing financial statements or operational reports
• Financial or investment management (for example, financing)
• Procuring or acquiring property to rent
• Planning, managing, or constructing long-term capital improvements

Please note that if a rental fails to satisfy these requirements, the enterprise could still be treated as a qualified trade or business for the purposes of the QBI deduction, provided it meets the definition of a trade or business under IRC § 162.

Related Information:

• Where do I enter income and expenses from a rental property?
• What is rental depreciation and how does it differ from an expense?
• What kinds of rental property expenses can I deduct?
• How do I handle capital improvements and depreciation for my rental?
• What can I deduct when refinancing rental property?

[Carl]

what happens when we make an LLC owner of the house?

Basically, you just spend a fair amount of money doing the transfer. Since an LLC (single member or multi-member) is considered a disregarded entity, it basically provides no protection what-so-ever to the owner(s) from any legal litigation that may be initiated by a tenant. Then for a multi-member LLC you have to file a physically separate tax return with a physically separate program to prepare the 1065 return. That's more money being spent every year.

We formed an LLC to manage these properties.

So just exactly how does an LLC manage the property any different that you do? You have more paperwork to do which means you have to spend more of your time and money doing it.  I'm not seeing any valid reason thus far, why you in your particular instance would want to do this. What's the benefit/gain?

There is also a new wrinkle in the tax code that allows businesses a tax-free 20% pass-through from income but this is not possible with schedule E

It most certainly is possible with SCH E income. Remember, rental income gets reported on SCH E *no* *matter* *what* kind of tax return you file - be it a personal 1040, a 1065 partnership/LLC return, an 1120 or 1120-S corporate return. It's still on SCH E and if you meet the requirements it does qualify for the QBI.

Now it's not easy to qualify for QBI with SCH E income. There's that 250 hours "directly involved" requirement. I myself have three rental properties and I"m telling ya right now, I'm amazed if I can actually reach 50 hours directly involved on all three properties combined.  That would require me to spend on average, just over 4 hours per week actually doing something beneficial to the property or to the tenant. Time spent at home "keeping the books" doesn't count for the requirement either. Remember, a home office is not allowed for passive SCH E income.

[Critter]

Do I qualify for the qualified business income deduction?

https://ttlc.intuit.com/replies/7036528

Can I get the QBI deduction on rental income?

Qualified business income, or QBI, is the net income generated by any qualified trade or business under Internal Revenue Code (IRC) § 162.

Rental properties are typically treated as passive activities, which are excluded from the definition of a qualified trade or business. However, rentals that qualify as trades or businesses under IRC § 162 are not considered passive, and that means their income can qualify for the QBI deduction.

To provide preliminary guidance to this popular question, the IRS recently released Notice 2019-07, the key points of which we've summarized below. We expect that IRS guidance will continue to evolve around this topic, and will provide updates when that occurs. Bookmark this page and check back often!

Exclusions

Income from these types of rentals is specifically excluded for the purposes of the QBI deduction:

• Passive rental activities that are not considered a trade or business
  • For example, a single-family dwelling rented out for a year or more in which there is little or no interaction between the landlord and the tenants other than periodically collecting rent and the occasional repair
• Property used as a residence by the taxpayer for any part of the year under IRC § 280A
  • This includes vacation homes, cabins, seasonal or "snowbird" residences, etc.
• Triple-Net (NNN) leases, where the tenant or lessee pays real estate taxes, insurance, and maintenance in addition to rent and utilities
• Rentals located outside the United States
• Land rentals

If your rental or rental activities fall into any of the above categories, you can't take the QBI deduction on the income.

Real Estate Professionals

If you’re a real estate professional for tax purposes (that is, over 50% of the personal services you performed in business during the tax year were in a real estate business you materially participated in for more than 750 hours that same year) then your rental income qualifies for the QBI deduction, provided all the other conditions are met.

Everybody Else

What if you own a rental – or three – but don’t qualify as a real estate professional? Turns out you can qualify for the QBI deduction, as long as your rental activities constitute a trade or business.

Generally, this means each rental real estate enterprise (a rental property or group of similar rental properties, including K-1 rental income) must satisfy these requirements:

1. Each enterprise has its own books and records to track income and expenses;
2. At least 250 hours of rental services are performed per year per enterprise; and
3. (Starting with tax year 2019) Contemporaneous records of services performed are kept which includes who performed the service, description of service, the date of the service, and how long it took (who, what, when, and how long).

Rental services can be performed by the owners or by their employees, independent contractors, or agents and would include things like:

• General operation, maintenance, and repair of the property
• Purchasing materials
• Property management activities
• Supervising employees and contractors
• Advertising the property for rent
• Tenant selection and background checks
• Negotiating and executing leases
• Collecting and depositing rent

Activities excluded from the definition of rental services include:

• Time spent traveling to and from the property
• Reviewing financial statements or operational reports
• Financial or investment management (for example, financing)
• Procuring or acquiring property to rent
• Planning, managing, or constructing long-term capital improvements

Please note that if a rental fails to satisfy these requirements, the enterprise could still be treated as a qualified trade or business for the purposes of the QBI deduction, provided it meets the definition of a trade or business under IRC § 162.

Related Information:

• Where do I enter income and expenses from a rental property?
• What is rental depreciation and how does it differ from an expense?
• What kinds of rental property expenses can I deduct?
• How do I handle capital improvements and depreciation for my rental?
• What can I deduct when refinancing rental property?

https://ttlc.intuit.com/replies/7122193

The website at https://www.wgcpas.com/irs-provides-a-safe-harbor-test-for-section-199a-and-rental-real-estate/ does a pretty good job of putting it into plain english us common folk can understand. 

Does time spent on Accounting and on activities required by the business structure (e.g., LLC membership meetings, reports, etc.) count towards the 250 hours?

No. The 250 hours of rental services are performed during the year with respect to the enterprise. Membership meetings, reports, etc. are not "rental services with respect to the enterprise" since they are of no benefit to the tenant. Excluded from rental services are financial or investment management activities, planning, managing, or constructing long-term capital improvements, or hours spent traveling to and from the real estate.

Does each activity need to be logged with beginning time and ending time or is it sufficient to report hours worked on each day on each type of activity?

The taxpayer maintains records, including time reports and logs, to support the hours, dates, description and provider of the services performed. Understand that this does not mean that "you" personally have to perform the service. For example, if you pay your A/C guy to come out and service the A/C and it takes them three hours, that's 3 hours that "YOU" provided because you paid your A/C guy to perform and provide that service.

In a rental business aggregated of several Schedule E Properties, does the log need to identify the specific property each activity was conducted for?

You actually get to chose. But once a selection is made (with limitations) you can't change it year to year.  The primary limit is that you can't combine residential rental and commercial rental as a single aggregate entity. One reason is because commercial rental and residential rental have different depreciation schedules under MACRS.

[varunagrawal]

What is the benefit of having husband and wife in a LLC to hold the title of the investment property? It just sounds like more tax paperwork for a partnership.