Deducting rental expense/depreciation on a co-owned property (not yet married)

[vchan08]

My significant other and I are purchased a co-owned rental property. Since we are not married, I do not plan on taking any of the deductions but rather let her claim 100% of it. 

We have a joint bank account which we used to pay all the expenses out of. Would there be any concern that it is a joint account. Obviously if the IRS were to see both our returns, only one of us would have the expenses claimed.

Please let me know if there would be any concerns to this or what would be the best route.

[tagteam]

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@vchan08 wrote:

Please let me know if there would be any concerns to this or what would be the best route.

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You should definitely seek legal counsel and tax guidance regarding this entire relationship and property ownership. Since you are not married, you need some sort of agreement concerning selling the property, buyout of the other party, etc.

Otherwise, mere co-ownership of property that is maintained and leased or rented isn't a partnership. 

See https://www.irs.gov/instructions/i1065#idm140538038077584 and Treas. Reg. §301.7701-1(a)(2)

Thus, you are pretty much free to decide on any allocation you desire.

[vchan08]

If money comes from a joint account, is there a rule that the IRS will only allow each person to deduct their ownership percentage? For example, both of us pay mortgage payments and property taxes equally - does the IRS say that each person can deduct 50% each? What if one decides not to deduct anything, can the other person deduct 100%? 

I just want to be sure that if we both pay for these expenses, it will be considered okay if only one person decides to take the full deduction (assuming that the other does not) since this is outside community property.

[tagteam]

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No, you can have any arrangement you prefer.

[Carl]

There are lots of concerns with this, and I'll only address the major one. I am assuming the following:

 - The two owners of the property are not married and therefore do not file a joint tax return together.

 - Both of the owner's names are on the deed.

 - Both of the owner's names are on the mortgage.

The major issue I want to address here has to do with when you sell or otherwise dispose of the property in later years. If each of you report your 50% separately on your individual personal 1040 tax returns, then each of you will be designated and equal percentage of *EVERYTHING*. That's half the depreciation recapture, half the expenses, and half the sale price. This is assuming you both claim 50% ownership on your tax returns. You could have it where one claims 90% ownership and the other 10% ownership. But my point is, one of you can't claim 100% ownership and the other claim zero percent ownership when the fact is, that's not true. But never say never. There's what I see as a better way.

For the rental, file a 1065 - Partnership Return. With this setup, your percentages don't have to match up and it won't raise any flags either. With the partnership return each of you claims 50% ownership, and it's still no problem for only one of you to claim all the expenses, all the depreciation, all the income, and all the proceeds from the sale.

In fact, with a partnership, expenses could be split 30/70, depreciation could be split 90/10, rental income could be split 0/100 and proceeds from a sale years down the road could be split 99/1 if you like. This is very easy to do with a partnership setup on a partnership return and so long as 100% of everything is accounted for, it's not an issue and won't raise any flags or eyebrows with the IRS.

One reason for doing this is because if both names are on the deed and/or mortgage, then both of you are legally liable for and obligated to pay the property taxes, as well as the outstanding mortgage. If one "skips town" then the bank/taxing authority will go after the first one they can find. So if person A skips out and person B picks up the landlord responsibilities, then person B will have no problem with claiming/deducting/reporting what they pay/receive to the IRS.

[vchan08]

thanks Carl!

[tagteam]

A partnership is actually an agreement whereby two or more individuals (partners can also be entities) agree to conduct a trade or business, contribute money, property, skill, and/or labor, and expect to share in profits and losses.

Therefore, a partnership in which one partner will retain all of the profits and losses (in the form of claiming all expenses and retaining all income and proceeds from a sale) is not really a partnership at all; it defies the very definition.

An individual can, however, designate another individual or entity to receive all of the income and claim all of the expenses from his/her share of ownership in certain property because mere co-ownership of property that is maintained and leased or rented is not a partnership; ownership is not claimed on an individual  income tax return, rather income, expenses, profits, and losses are claimed on an individual income tax return.

Additionally, note that general partners in a partnership are personally liable for the debts of the partnership and jointly and severally liable for the actions of other partners taken in the ordinary course of partnership business.

Good luck!