Is it ok to pay property management fees from a single member LLC that owns an investment property to another single member LLC that is the property management company?

[brewsj]

I own a rental property through a single member LLC and also have a property management company with a single member LLC structure that manages the property. Both LLC's taxes pass through to my personal tax return. Is is ok to report property management fees/income on Schedule C & issue a 1099 from the property management LLC to the owner LLC which would deduct it on Schedule E? Since both LLCs taxes are on one tax return, I'm wondering if it's ok to have the property management income and expense deduction on the same return but different Schedules.

[Anonymous_ · Accepted solution]

What is the rationale for charging yourself a management fee and reporting that fee as income on Schedule C while deducting that same amount on Schedule E?

Your single-member LLCs are actually not pass-through entities since pass-through entities pass through income, expenses, deductions, et al, to members, partners, shareholders (of S corporations), and beneficiaries of certain estates and trusts.

Your LLCs are different as they are indistinguishable from you for federal income tax purposes. As a result, you would need to have a business purpose for this transaction other than some sort of tax benefit. If not, then the IRS could disallow reporting as you intend on the grounds that it lacks economic substance.

[Mike9241]

even a "business purpose" probably wouldn't work.  even though there are two LLCs there is only one tax entity - yourself. it's like transferring money from your left to your right pocket.   you have neither income or expense in doing this.

[brewsj]

@Mike9241 @Anonymous_ Thank you both! For a little more background, the property was acquired with a 1031 exchange and we had to setup the ownership as tenants-in-common (TIC) with another entity which requires a property management company to manage the property. IRS requires this in order to honor the TIC agreement rather than classifying the ownership as a partnership which would nullify the 1031 in our situation.

Can you let me know if either or both of these options would work instead?

1) Only put the percentage of the property management income on my tax return that matches the % TIC ownership of the other entity. I think this works because as you said the ownership % of my other LLC is just like passing money from one pocket to another so that % shouldn't be considered income/expense.

2) File to have the property management LLC to be taxed as a corporation rather than a single member disregarded entity. This would would require a business tax filing but should allow the full property management income on that return and my ownership % of the expense on my personal return.

[Anonymous_]

If you have a separate entity, that is a different matter,

[Mike9241]

i just want to make sure I understand the situation.  there is one LLC of which you are the only member that owns the real estate.    there is a second LLC that manages the real estate that someone else is a member and maybe yourself.

if the other party is the only member it should be furnishing you with a listing of income it receives and expenses it pays on your behalf on the rental property because those are reportable on your return along with the management fee paid

if the second LLC is multi-member a partnership return filing is required. if you are the other member you get a k-1. reporting of the rental income and expenses, except for the management fee, would be the same as above because the LLC is an agent, not the owner.  it would only report the management fee as income and expenses associated with collecting the rent and paying the expenses  

[Anonymous_]

This needs clarification, as @Mike9241 indicated, @brewsj.

Your initial post stated, "I own a rental property through a single member LLC and also have a property management company with a single member LLC structure that manages the property.". 

[brewsj]

@Anonymous_ @Mike9241  Thanks guys. Sorry I wasn't more clear, hope this helps:

There are 3 LLCs:

LLC1: I own a single member LLC that is a TIC co-owner of the rental property

LLC2: I own another single member LLC that is used for the property management and collects management fees.

LLC3: Someone else owns a different LLC that is a co-owner of the rental property with LLC1

Before creating this post, I was expecting to put income/expense for LLC1 on Schedule E and LLC2 on Schedule C of my personal tax return. I am questioning if it's ok to show property management income for LLC2 and the corresponding expense for LLC1 on the same personal return.

There is no K-1 involved since none of the LLCs are partnerships. I'm just not sure if I should only be filing the income for LLC2 that corresponds to LLC3's % of the property management expense (and not LLC1's %) since LLC1 is also a disregarded entity owned by me (money in one pocket to another).

[Mike9241]

LLC1: I own a single member LLC that is a TIC co-owner of the rental property

LLC2: I own another single member LLC that is used for the property management and collects management fees.

in my opinion, if the management fees it collects are from LLC 1, then my previous thread applies. LLC 1 and LLC 2 for tax purposes are one taxpayer/tax entity. so such fees paid from 1 to 2 would not be an expense to 1 nor income to 2. you are paying yourself. if it manages other property owned by different tax entities then those management fees received would be income even if it's 3   

LLC3: Someone else owns a different LLC that is a co-owner of the rental property with LLC1

any fees 1 pays to 3 for managing 1 would be deductible since it is a separate tax entity.

depending on all the facts and circumstances the IRS could conclude that 2 and 3 serve no business purpose and were merely formed to convert rental income into earned income so certain tax benefits could be obtained.   

see if others comment on this thread. 

[Anonymous_]

---

@Mike9241 wrote:

depending on all the facts and circumstances the IRS could conclude that 2 and 3 serve no business purpose and were merely formed to convert rental income into earned income so certain tax benefits could be obtained.   

---

I agree; that certainly could be the conclusion based upon the information provided here.