Mixing Passive and non-Passive income?

14 Replies

I already have an e-mail into my attorney/CPA with this question (so don't bother telling me to check with one), but while he's answering the 80 or so e-mails before mine, I thought I'd post this question here to get some quicker answers and/or ideas for other things to ask.

I currently have a California LLC formed to hold our two rental properties. Hence, all the income is considered passive. If my LLC were to generate some non-passive income, would that make ALL the income non-passive or can I simply separate them from each other?

For example, let's say there is a company that wants my LLC, ergo me, to perform some services for them. This would clearly not be passive income. If I were to perform this work and have my LLC send them the bill, would these earnings "contaminate" my passive income thereby screwing up my tax situation?

I would like to simply keep the two streams of income separate and treated accordingly rather than set up yet another entity, like an S-Corp.

Thanks everyone!

Thanks Charles!

You burn the midnight oil as well? :zzz:

That'll be great if I can generate two different streams of income with one LLC, especially since entities cost $800 a year, EACH, in Kalifornya. :pissed:

But I'll still wait and see what my attorney/CPA has to say since I don't want to screw up any of the planning he painstakingly worked on for me. :whistle1:

Mitch,

Watch out for CA. LLCs in CA are hit with a franchise tax that does not apply to S-Corps. Another issue to consider is how you will be taxed on active income through an LLC. If the LLC is not set up to be taxed as a S-Corp you will be treated as a sole proprietor.

Originally posted by Clint Coons:
Another issue to consider is how you will be taxed on active income through an LLC.

Thanks Clint, but that is my precise question. What happens if my LLC earns non-passive income along with its passive income? According to Charles, I can simply separate the two and report them accordingly. Do you agree?

Originally posted by Mitch Kronowit:

Thanks Clint, but that is my precise question. What happens if my LLC earns non-passive income along with its passive income? According to Charles, I can simply separate the two and report them accordingly. Do you agree?

My answer would be that you HAVE TO seperate them. In reference to your original post, in no way can you magically turn passive income into non-passive.

Originally posted by Clint Coons:
If the LLC is not set up to be taxed as a S-Corp you will be treated as a sole proprietor.


Actually, not only can you elect to have your LLC treated as an s-corp, you can instead elect to have your LLC treated as a c-corp or a partnership for taxation purposes if you choose.

If you don't elect a specific type of taxation for your LLC (using IRS Form 8832), you will be taxed as a sole proprietor if you have a single-member LLC and as a partnership if you have a multi-member LLC.

Mitch it is always better to separate these activities inside two separate businesses, but it is possible to have both types activities with in the same LLC.

Passive activity though is not passive for everyone. If passive activity is mixed with nonpassive activity it might be treated as ordinary income in an audit. These types of activities need to be clearly separated, but can still be inside a single business.

Originally posted by Charles Perkins:
If passive activity is mixed with nonpassive activity it might be treated as ordinary income in an audit. These types of activities need to be clearly separated, but can still be inside a single business.


That's my concern. I imagine the key to keeping the two activities separate is to document, document, document. Thanks again Charles.

As you are probably also aware the type of activity, volume and intent play a factor in this as well.

If you could be classified as a dealer then, I would recommend a wholly separate business entity for any passive activities you might have. You would have far more trouble in that scenario convincing an auditor that some RE transactions were purchased intentionally as long term rental properties rather than renting the properties with the intent of selling them when a buyer is found.

I agree with Charles that the activity, if it is flipping property, should be separated. As I stated earlier running an active business through an LLC in CA (regardless of how it is treated for federal income tax purposes) will increase your tax liability to CA. Simply put I always separate passive activities from no passive for tax reasons and asset protection concerns.

Hi Clint! Welcome to BP! It's good to see you here and look forward to your expertise. By the way, are you related to the Coons' in So. Ca? It's beggining to look like a convention of Seattle investors!

This is sort of my understanding, and some might be a slight repeat of posts above: My understanding is that an LLC is virtually irrelevant as per tax structure. HOW you elect to be taxed is what's important. (sole proprietor, Scorp, c-corp, etc.) The LLC is simply a "shell" that is supposed to offer liability protection. I have a single owner LLC ofr my rental properties but I file a schedule E for each property (and my accountant has me setup a property called "generaL' for expenses not related to one single property, such as inspections, office, etc.)

The only other thing I've been advised is that, per suggested above, you have two separate companies if you buy hold vs. flip because the flipping might be considered ordinary income if you have to be considered a "dealer" and by using SCORP for this activity you can limit how much income is taxed for SS/MED by virtue of paying yourself only a portion of net income as wages.

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