Rental Property transfer to LLC

[SteveO65]

I transferred title of rental property to a multi owner LLC (3 minor participants <1%) in 2017. Do I file a Schedule E & how is the transfer to the LLC reflected as a sale?  Also to the extent there was a passive loss in the prior year (with a rental gain in 2017) how is that reflected or captured in my 2018 return?

[Carl]

Several things to point out here, not all of them having to do with taxes, but it is important enough to make sure you're aware of it.

 - If the property has a mortgage on it, and you changed anything on the title of the property without the written consent of the mortgage holder, you very well may have violated the terms of the mortgage. The lender will find out about this when they receive the next property tax bill to be paid from your escrow account. So it's perfectly possible that this action could make the balance of the loan due and payable immediately, and if not paid in full upon demand, the property can be (and usually will be) foreclosed on for violating the terms of the mortgage. You lose everything.

 - Since the IRS considers a single-member LLC as a disregarded entity (meaning they do not recognize a single member LLC as a separately taxable entity) then transferring rental property to such an entity is a waste of time and money. All rental income is still reported on the SCH E, and absolutely nothing concerning the rental property (income or expenses) is reported on SCH C.
People make the mistake of believing transferring property from personal ownership to LLC ownership (single member or mutli-member LLC as is your case) provides a greater degree of protection in the event a tenant sues. Nothing could be farther from the truth. The "veil of protection" offered by an LLC is about as effective as a wet paper bag. If you feel you need the protection, then do one of two things.

 a) If you establish an S-Corp and then "sell" the property to the S-Corp that will offer about the same "veil of protection" as buying additional liability insurance will. But it will be much more costly and requires much more paperwork on a never-ending continuing basis. 
 With an S-Corp, you have to deal with required state quarterly filings, documented "board of directors" meeting minutes (which are also sent to the state), yearly tax filings at both state and federal levels, as well as legally required minimum taxable distributions to all owners of the S-Corp. If you don't know what you're doing with such an entity, you can quite easily lose quite a lot (if not everything) to back taxes, interest, fines, penalties and late fees. For example, S-Corp returns are due by March 15, and for each month the return is late, the late filing penalty is $125 per month for the federal return. There will also be such a penalty for late filing with the state. An S-corp is considered a separately taxable entity that files it's own 1120-S tax return and will issue all owners at least a K-1. There could be other tax reporting documents the S-Corp could be required to issue also.
Finally, since an S-Corp is considered a separately taxable entity, you can't just transfer property to it very easily. Lenders usually require an S-Corp to apply for it's own mortgage. But if the S-Corp does not already have any assets, most likely that loan application would be disapproved. Lenders are wary of this also, since if the S-Corp files for bankruptcy, then lender's risk of losing can be much higher.

 b) First, there's the insurance angle. Just increase your liability coverage on the rental dwelling policy. Understand the different types of insurance for real estate. a Homeowner's policy is for your primary residence. It does not cover rental property. So when converting property that used to be your primary residence, to a rental then you *MUST* update the property insurance. Rental property is a type of business property, and a homeowner's policy does not cover anything at all on any type of business use property. So if you have a claim on your rental property and file that claim against a standard homeowner's policy, the insurance company will deny your claim and you will lose in court if you think you can go that route.
   With a proper "rental dwelling policy" the absolute lowest amount of liability insurance I've ever seen on such a policy, is $300K. If you feel that's not enough (such as in CA for example) then you can always increase the liability coverage and it's a heck of a lot cheaper than doing anything else. I have one rental property myself that, since it's rather dated, I feel $300K is not enough. So for an extra $100 a year (give or take a few bucks) I increased the liability coverage to $1M.

Now in your case, since you have three named owners of the property and the owners are not married to each other (obviously, since there's three)  you need to file a physically separate IRS Form 1065 Partnership Return for "the business". That tax form is used for both partnerships and multi-member LLCs. Basically at the federal level for tax purposes only, the only difference between a partnership and a multi-member LLC is the spelling. (Literally!)
     The partnership will still report all rental income/expenses on SCH E as a part of that 1065 partnership return. It doesn't matter the percentage of ownership here. It's still a partnership. So the partnership will issue each partner a K-1 which each partner will need in order to complete their personal tax return. It also doesn't matter if two of the partners are married to each other and file a joint return. Each individual partner receives their own K-1 and reports it on the personal tax return. So basically, you can't even start your personal tax return, until after you have completed and filed the 1065 Partnership return and all K-1's have been issued to all owners/partners/investors.

So bottom line here is, you will need TurboTax Business (different from Home & Business) to complete and file the 1065 Partnership Return and issue all required K-1's. Understand that TurboTax Business is not available as an online product, or for MACs. It's for the Windows platform only. You can get it and download the CD installation file right now on line at https://turbotax.intuit.com/small-business-taxes/ but you may find the CD significantly cheaper if you purchase it over the counter at a local authorized reseller in your area.

Overall, I would highly recommend you seek the services of a tax professional in your local area if you are not comfortable with this. You have a lot to do for the first year, assuming 2017 is the first year you owned the rental property, or the first year it was owned by more than one person. You first have to transfer all assets from any personal tax return it was reported on previously, to the partnership return while taking into account and any all prior depreciation taken on those assets prior to the transfer. While this is perfectly doable with the TurboTax software, if you don't know what you're doing a screw-up can be quite $costly$ down the road.

[SteveO65]

Understand the 1065 requirement; not clear on how to transfer the asset in TTax & capture the prior year loss carryforward?

[Carl]

First understand that you can not file either your personal return (and neither can any of the partners) until you first complete the partnership return. That's because of the K-1's the partnership will issue to each owner, which they need to complete their personal return's with.
First, you start by preparing the personal return. For the rental property you will be showing on your return that the property is removed from service for personal use. Basically, you're converting the property from rental real estate, to personal use. THe date of conversion will be one day *before* it is acquired by the partnership. That date should not be a date before the partnership is established. If it is, then you will have to deal with "unqualified use" down the road whenever you sell or otherwise dispose of the property, and you don't need the headache that entails.

In your personal return you start working through the Rental & Royalty Income (SCH E) section of the program and on the 2nd or 3rd screen in select the box to indicate you converted it from rental property to personal use in 2017. Then press on "as if" you did not do that.
On the summary screen you will enter all rental income received and all rental expenses incurred only up to the date of conversion to personal use. You will NOT enter amounts for the entire year here.
Next, in the assets/depreciation section you must work through each individual asset listed (Of which the property itself will be listed there at an absolute minimum) and on the screen that asks if you stopped using the asset in 2017, click YES.
On the screen that shows you cost information, you need to write down on a separate peice of paper the name of the asset *exactly* as it appears in the program, the cost of the asset, and if listed, the cost of the land. You also need to write down any dates, such as the purchase date and/or in service date of the asset. You will need all of this information when you get to entering it in the 1065 return.
Then on the "special handling required?" screen, click YES. DO NOT CLICK NO or you will be asked for sales information. (You did not sell the property.)
When you get to the screen that shows you the depreciation amount for 2017, click the "details" button on that screen and write down everything presented. You will need all of that information for the partnership return.

[SteveO65]

Why is there a long term gain with the transfer?

[Carl]

Because you owned the property for at least a year or more prior to selling it to the partnership.
For others reading this, this response takes into account additional information in the OPs other thread on this at <a rel="nofollow" target="_blank" href="https://ttlc.intuit.com/questions/4495143">https://ttlc.intuit.com/questions/4495143</a>

[jm4]

yes

[kathirpalanisamy]

Hello,

I am trying to understand how to file taxes in Turbo Tax for properties transferred to a single member LLC. Under LLC do you put that property was bought or acquired?

Thanks

Emily

[AmeliesUncle]

@kathirpalanisamy   Unless the Single Member LLC made an election to be taxed as a corporation (which should NOT be done without the close assistance of a tax professional), for income tax purposes it is treated as if the LLC does not exist.  So just report it as if it was in your name as a rental property.  

[Carl]

Your single member LLC is considered a disregarded entity by the IRS. A single member LLC reports *EARNED* income. Rental income is not earned. It's passive income. Rental income and expenses are reported on SCH E as a physical part of your personal 1040 tax return. There are no exceptions. So if residential rental real estate is the only thing in your single member LLC, then you will not file a SCH C at all.

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 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.

[AJ96]

@Carl 

We transferred the property to an LLC mid year. We know how to enter the depreciation information on our personal tax return and dispose the property properly. I followed your instructions on how to enter the property in the 1065 and how the business should have a start date prior to the first day the property was put in business. However, when I enter the prior depreciation on 1065 to be the total of previous years + the depreciation taken on the individual return for 2020, Turbo Tax business is giving me the wrong depreciation number. It's giving me depreciation for all of 2020 instead of just the portion of the year to where the LLC owned it.

If the property was moved to the LLC on January 1st and no depreciation was deducted on our personal tax return, then it would have been easy to enter it because the LLC can capture the full year depreciation. Do you recommend doing that? Although, we didn't transfer the property until October 2020 but for tax purposes, it seems like it would be the same. 

[DianeW777]

At the bottom of the list of assets is a button labeled "Add an Asset". This will lead you to questions that place the asset in a class, etc.....

SELECT "OTHER ASSET" type to customize years, class, method, etc. manually.

I would recommend entering the start date as the date the property was transferred to the LLC or whenever the LLC started managing the property or otherwise started conducting business operations.

Note: If you're using the desktop software you also have the option to go to forms, got to the schedule E worksheets for the property, click on depreciation, click the magnifying glass to the left, and "create a new copy" to add an asset worksheet for an asset not yet listed. This is especially useful if you are moving to TurboTax and have a list of assets already in service to enter, as you describe.

[AJ96]

@DianeW777 @Carl 

To subtract the portion of 2020 that has already been depreciated on our personal tax return, we added a negative value on line 16 and left a comment explaining the reasoning. The final number on line 22 turned out to be correct and what we were expecting. Do you think that is sufficient? Is there a better way to achieve this.

[Carl]

Just understand that when you modify things in the forms view, chances are you will not be able to e-file the return. You'll have to print, sign and mail it to the IRS. Same will hold true for your state return if applicable.

[Facsmann]

@Carl 

My wife and I created LLC late last year and transferred property to start LLC in Jan 1, 2022. We have multiple properties, with no mortage, running multiple schedules in Turbo Tax Home and Business.

We have Ein number for the LLC. Do i do taxes in Turbo Tax Business and create K-1 for ourselves. How do i tranfers depreciation schedules etc to Turbo Tax Business.