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Self Employment Tax on Rental Income held in an LLC?

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Brandon Turner Verified

Real Estate Investor from Montesano, Washington

Feb 02 '10, 02:07 AM


Any tax pro's out there?

If I own a LLC that owns an apartment building, do I have to pay self employment taxes on the cashflow each month? I know normally passive income does not get taxed with self employment, but if I don't technically own the apartment (I own the LLC that owns it), is it still passive income?

Also, to throw another wrench in, I have a separate LLC set up to manage the LLC that owns the building. Both are taxed as a "sole prop".

Any thoughts? Thanks

brandon


Edited Jun 26 2010, 11:28


Medium_bp-squareBrandon Turner, BiggerPockets
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Dave T

Real Estate Investor from South Carolina

Feb 06 '10, 03:50 PM
3 votes


Brandon,

Passive income does not change its character just because it is earned by an LLC. The rental income for the LLC that owns the building will still be passive income. Since this LLC is a disregarded entity, report your income and expenses on Schedule E as if the LLC did not exist.

I assume that the LLC that does the property management receives a management fee for its services and you, as the sole member of the LLC, are the property manager. If so, then this LLC is an active income business and the income is subject to self employment income taxes. The income and expenses for this LLC are reported on Schedule C as if the LLC did not exist.

I don't see what your LLCs accomplish. The LLCs are disregarded entities. You are managing your own properties. The LLC provides no asset protection, so why have them?

All you really accomplished with a management LLC is converting passive income to active income and as a consequence paying self-employment income taxes.


Edited Jun 26 2010, 11:32 by Dave T


Brandon Turner Verified

Real Estate Investor from Montesano, Washington

Feb 07 '10, 12:17 AM


Hey Dave. I set up the LLC's because they do provide some asset protection, or so i thought. They don't? I think I read it in a book somewhere, but you never can be too sure.

Obviously I want to avoid paying taxes as much as possible, especially the SE Tax. Suggestions?

I think I need to see a tax lawyer or accountant soon anyways. The question I posted is slightly theoretical, since I have not actually purchased the apartment yet. So, I'll make sure to find out for sure before I do. Thanks!


Edited Jun 26 2010, 11:32


Medium_bp-squareBrandon Turner, BiggerPockets
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Website: http://www.BiggerPockets.com
VP of Marketing and Communication - BiggerPockets.com Follow me on Twitter! @BrandonAtBP


Dave T

Real Estate Investor from South Carolina

Feb 12 '10, 03:07 PM
1 vote


When the LLC promoters talk about asset protect, they usually set the scenario where your LLC is sued and your personally owned assets are shielded from exposure by the "asset protection" afforded by the LLC.

What they don't tell you is that when you self manage your own properties, either as the manager of a single member LLC or as a sole proprietor, then nearly any lawsuit arising out of your rental activity will be over something that you did as the property manager/owner, or something you should have done but didn't.

Since you personally manage the property, you are also personally liable for your actions. Does not matter that you were acting on behalf of the LLC.

That is why I say a single member LLC for rental property that you will manage yourself provides no asset protection.

Make sure you thoroughly discuss this point with your attorney.

For the property you self manage, just make sure you have adequate liability insurance. I can purchase liability coverage on my hazard insurance policy for an additional $25. A lot cheaper than the cost of establishing and maintaining an LLC, especially when most tenant lawsuits are settled within the limits of the insurance policy coverage anyway.


Edited Jun 26 2010, 11:38


Mark N.A

Real Estate Investor from North Carolina

Feb 12 '10, 08:21 PM


Brandon:

Around here many big RE investors own property in their own name. Others choose to use entities such as LLCs, etc. Either way works.

But the ONE THING all these succesful investors share in common is that they have built a team for themselves of EXPERTS to guide them, and I'm specifically talking about ATTORNEYS and ACCOUNTANTS and GCs and so forth.

I would be interested in learning your reasons for approaching REI differently.


Edited Jun 26 2010, 11:38


Bill Gulley

Real Estate Investor from Springfield, Missouri

Feb 12 '10, 09:00 PM


Originally posted by Dave T:
Brandon,

Passive income does not change its character just because it is earned by an LLC. The rental income for the LLC that owns the building will still be passive income. Since this LLC is a disregarded entity, report your income and expenses on Schedule E as if the LLC did not exist.

I assume that the LLC that does the property management receives a management fee for its services and you, as the sole member of the LLC, are the property manager. If so, then this LLC is an active income business and the income is subject to self employment income taxes. The income and expenses for this LLC are reported on Schedule C as if the LLC did not exist.

I don't see what your LLCs accomplish. The LLCs are disregarded entities. You are managing your own properties. The LLC provides no asset protection, so why have them?

All you really accomplished with a management LLC is converting passive income to active income and as a consequence paying self-employment income taxes.


Dave, while your advice seems on target with respect to taxation, I really do not agree as far as your comment concerning liability protection offered by the LLC. If one is properly drawn and maintained with accurate minutes (as most are not) there can be benefits. LLCs are not treated the same in every state and in every jurisdiction, perhaps where you are what you advise may be true, but it certainly is not everywhere. I nelieve I have seen you saying this before and it was pointed out before. I know you are not an attorney because if you were you would not be saying that. Sounds like an insurance agent speaking, and that too is a good idea, but it sounds like you may have lost a case or perhaps you were a party to a matter that left a bad taste in your mouth for LLCs, keep in mind that when something is said here it is put out to the whole country (or world). Bill


Edited Jun 26 2010, 11:38 by Bill Gulley


Brandon Turner Verified

Real Estate Investor from Montesano, Washington

Feb 13 '10, 02:19 AM


NC Mark - I agree wholeheartedly. I need a CPA. I have the attorney, but I wanted to wait until after I bought the apartment to go to a CPA. Probably not real smart, but I figured CPA's are a bit busy with tax time right now, and my stuff would be pushed to the back anyway. Am I wrong?

Also, I am definitely jumping into a bigger game than my "pay grade" deserves. Having a team of pro attorneys and cpa's would be wonderful, but I've never been able to financially justify them while occasionally flipping $30,000 houses. I know its not the smartest thing, but I'll take the risk for now.

Also, my post on here has more to do with future profit projections than it does setting up the right structure. If I knew I had to pay an extra 15% on any cashflow I make, thats a huge dent in my projections.

Thanks guys!


Edited Jun 26 2010, 11:38


Medium_bp-squareBrandon Turner, BiggerPockets
E-Mail: [email protected]
Website: http://www.BiggerPockets.com
VP of Marketing and Communication - BiggerPockets.com Follow me on Twitter! @BrandonAtBP


Brian Levredge

Real Estate Investor from Chattanooga, Tennessee

Feb 13 '10, 03:50 AM


Brandon,

Talk to a CPA that specialized in RE, or better yet talk to a tax attorney. There are ways to shelter the income above and beyond the norms that don't turn it into active income.


Edited Jun 26 2010, 11:38


Dave T

Real Estate Investor from South Carolina

Feb 13 '10, 03:01 PM


Originally posted by Bill Gulley:
I really do not agree as far as your comment concerning liability protection offered by the LLC.


Bill,

I am not making a general comment or a broadbrush statement. The LLC under discussion is a single member LLC and the rental property is self managed. I don't deny that an LLC may have value for certain investors, however, my comments are aimed at this specific instance.

Have your attorney read my follow on comments about this specific situation and then come back and tell us whether your attorney agrees or not.




Edited Jun 26 2010, 11:39 by Dave T


E V

Mar 10 '10, 09:22 AM


I have an LLC setup to hold title to the real estate for liability reasons and tax benefits vs. holding it in my personal name or trust. Then I have an LLC to manage it. The reason for the managing LLC is for accounting purposes, in addition, this managing LLC also manages other LLC's that I have to own other real estate. So you can say the managing LLC is an "umbrella" entity holding all. This managing LLC pays me my income as an officer. It makes taxation alot easier to manage, in addition to the liability. By the way, my holding LLC's are in CA for the property is in CA. My managing LLC is a Nevada one to protect from Charging Orders issues.


Edited Jun 26 2010, 12:00


Bill Gulley

Real Estate Investor from Springfield, Missouri

Mar 10 '10, 09:58 AM


Originally posted by Dave T:
Originally posted by Bill Gulley:
I really do not agree as far as your comment concerning liability protection offered by the LLC.


Bill,

I am not making a general comment or a broadbrush statement. The LLC under discussion is a single member LLC and the rental property is self managed. I don't deny that an LLC may have value for certain investors, however, my comments are aimed at this specific instance.

Have your attorney read my follow on comments about this specific situation and then come back and tell us whether your attorney agrees or not.





Dave, it is the same as for a general partner, since that is the capacity the single member is acting, he/she is personally liable to the LLC, not to the public per se' but could be as well. This is a state by state issue as well. Local custom rules. I had to vote you up for your first post, very good points and I was not meaning to sound so emphatic. How the member conducts themselves and maintains the entity is paramount. If a tenant were charged double rents and beagn an eviction, yes the member would be in trouble, for a trip and fall, no, not to the extent of personal assets. Bad conduct or gross negligence is not well protected in any entity. Size matters as well. Good points. IMO Bill


Edited Jun 26 2010, 12:00 by Bill Gulley


Mitch Kronowit Donor

SFR Investor from Orange County, California

Mar 11 '10, 11:47 PM


Originally posted by Brandon Turner:
Also, my post on here has more to do with future profit projections than it does setting up the right structure. If I knew I had to pay an extra 15% on any cashflow I make, thats a huge dent in my projections.

We just recently formed an LLC in California. The strategy we used was to find a close trustworthy person to act as the "manager" for the LLC. That keeps my name off official documents (the LLC was formed as manager-managed vice member-managed). It also makes me a "passive" investor with no direct involvement with the company. The "manager" follows my instructions to the letter, but she is still the operating front for the entity. For tax purposes, I collect a distribution of profits as the member, but not a salary, hence so SE taxes.

Is all this clear? Great, now explain it to me! :wink:


Edited Jun 26 2010, 12:01


Tarun Kapoor

Minneapolis, Minnesota

Apr 17 '13, 07:44 AM


@Brandon Turner, Hi Brandon, the info on this thread is confusing to me. From my understanding one is not supposed to pay SE taxes on rental income.

I am in the same boat as you. I am looking to form an LLC for managing my properties (and i will be doing the property management). Will i have to pay SE tax on income ? Can anyone please clarify ?



Bill Walston

Real Estate Investor from Northeast TN, Tennessee

Apr 17 '13, 01:34 PM


@Brandon Turner, I'm sure @Steven Hamilton II will swear he NEVER thought he'd hear this from me ... but let me just say... you don't need a CPA... you need a "real estate knowledgeable tax pro"

That person may or may not be a CPA..Just don't limit your search to that designation :) There are some excellent tax guys and gals who choose not to be a CPA.

Now, if you need audit work or some such done, that's a different story ;)



Steven Hamilton II Verified Moderator

Real Estate Investor from Lake Villa, Illinois

Apr 17 '13, 10:48 PM
1 vote


To second what @Bill Walston said,

You may want to consider an Enrolled Agent someone designated and licensed by the Dept of Treasury in taxation.

-Steven



Medium_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


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