Do I need a partnership LLC to depreciate and write off expenses on a rental property

Washington, District of Columbia
Tax, SDIRAs & Cost Segregation
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Do I need a partnership LLC to depreciate and write off expenses on a rental property

David Cherkowsky
Investor · Alexandria, VA · Member since 2023 · 92 posts · 52 votes

I purchased a rental property earlier this year, and it will be my first year not taking the standard deduction. I met with a tax professional I found through BP, and in our planning call, she mentioned that if you are filing single, and make over ~$80k, then you cannot write-off any expenses associated with a rental property, or depreciate the property. The only tax benefits would be taxes and interest. 

She said to be able to use depreciation and write-off expenses, I would need to create a partnership LLC and have someone else be at least a 1% owner in the LLC.

I've read a few books on real estate tax planning now, but recognize there is a lot that I don't know. I'm mostly looking for a sanity check that this is required.

Thanks in advance for the responses...

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Jason MalabuteBusiness Member
Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 904 votes
1y

Hi David,

It sounds like there might have been a mix-up in what the accountant was explaining. I think they might have been referring to the Passive Activity Loss (PAL) limitations. With rental real estate, you can usually deduct up to $25,000 in passive losses, like depreciation and expenses, if you actively participate in the rental activity.

But here’s where income comes into play: if your modified adjusted gross income (MAGI) is $100,000 or less, you can take the full $25,000 deduction. Once your income gets between $100,000 and $150,000, that deduction starts to phase out and is completely gone by the time you hit $150,000. So, if your MAGI is over $150,000, you won’t be able to take those passive losses against other income, like your wages.

There isn’t actually an $80,000 threshold in the tax rules as far as I know, so that part might have been a misunderstanding. Hope that helps clear things up! Let me know if you have more questions about it.

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  • David Cherkowsky
    OP
    Investor · Alexandria, VA · Member since 2023 · 92 posts · 52 votes
    1y

    Thank you @Ashish, @Natalie Kolodij, @Sean Graham, @Michael Plaks. Really appreciate the responses. One thing to clarify is that I am not married filing separately. I am single. Poor wording in the original post.

    I emailed the CPA and said that the advise does not seem to be correct and received the following response:

    "Forming an LLC alone doesn't automatically turn passive losses into active losses. However, if you materially participate in a business or real estate activity within the LLC, the income may be classified as active, which could allow the losses to offset active income.

    Ex: Self-Rental: If you rent property to a business you actively run (like a business you own and operate), the rental income can be treated as active under the self-rental rule.

    Material Participation: Material participation is the key factor here. If you materially participate in the LLC’s operations, you may be able to treat the income as active.

    • a. Making significant management decisions
    • b. Regularly performing or overseeing maintenance and repairs
    • c. Actively marketing the property and handling tenant relations
    • Cost Segregation: allows you to accelerate depreciation by breaking down the property into different components, such as personal property (appliances, carpeting, etc.) and land improvements (landscaping, parking lots, etc.), which can be depreciated over a shorter period typically 5, 7, or 15 years rather than 27.5. It can convert what would be a passive loss into a deduction against active income


    You can do this all under your personal return w/out the LLC, but your losses will be limited even if you do a Cost Seg due to your AGI limitations."

    Reading that reponse, and all of the responses in this thread, I'm not really seeing how the LLC would help the tax situation.

    Thank you again for your time.

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    1y
    Quote from @David Cherkowsky:

    Material Participation: Material participation is the key factor here. If you materially participate in the LLC's operations, you may be able to treat the income as active.

      Material participation in a rental activity, with or without an LLC, still runs into PAL rules. LLC does not overrule it.

      Since you're single, you have a few weeks before the end of 2024 to marry some full-time Realtor or a contractor. If your spouse qualifies for the Real Estate Professional status, then it will cover both of you. And THEN material participation will open the deductions for you. Again, with or without an LLC, same exact tax result.
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    • David Cherkowsky
      OP
      Investor · Alexandria, VA · Member since 2023 · 92 posts · 52 votes
      1y
      Quote from @Michael Plaks:

      Since you're single, you have a few weeks before the end of 2024 to marry some full-time Realtor or a contractor. If your spouse qualifies for the Real Estate Professional status, then it will cover both of you. And THEN material participation will open the deductions for you. Again, with or without an LLC, same exact tax result.

       Lol thanks Michael! Maybe in 2025. 

      Quote from @Michael Plaks:

      Quote from @David Cherkowsky:

      Material Participation: Material participation is the key factor here. If you materially participate in the LLC's operations, you may be able to treat the income as active.

      Material participation in a rental activity, with or without an LLC, still runs into PAL rules. LLC does not overrule it.

      Sounds like an LLC does me no good then. Appreciate you helping me save a few hundred bucks and headache in creating it.

      1Reply
    • Max Emory
      Accountant · 100% Remote · Member since 2019 · 497 posts · 216 votes
      1y

      Hey @David Cherkowsky, I'm not sure how much vetting you did for the tax pro you found on BP but I'd recommend getting referrals for such an important position on your financial team. 

      BP is so large now, unfortunately, there are a lot of "professionals" advertising their services here but don't know the REI industry.

      So, to protect yourself in the future, I'd ensure at least a few other REIs have worked with the professional you choose to hire and have received enough value from them to refer their services.

      You can always ask the professional for references as well and they should have no problem providing a few if they are good at what they do.

      Just my 2 cents. Stay safe in the forums haha.

      Good luck!

      1Reply
    • Sean GrahamBusiness Member
      Investor , CPA · Detroit, MI · Member since 2016 · 584 posts · 248 votes
      1y
      Quote from @Michael Plaks:
      Quote from @David Cherkowsky:

      Material Participation: Material participation is the key factor here. If you materially participate in the LLC's operations, you may be able to treat the income as active.

        Material participation in a rental activity, with or without an LLC, still runs into PAL rules. LLC does not overrule it.

        Since you're single, you have a few weeks before the end of 2024 to marry some full-time Realtor or a contractor. If your spouse qualifies for the Real Estate Professional status, then it will cover both of you. And THEN material participation will open the deductions for you. Again, with or without an LLC, same exact tax result.
        Exactly. You still need REPS to take advantage. Materially participating in a rental property doesn’t allow the losses to offset active income without REPS 
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