Me and a partner formed an LLC earlier this year. We wanted to start investing in real estate and my partner has a few large assets he wants to protect. We split everything 50/50.
We are closing on our second property (a triplex) next week and I’m curious about how we will split the tax benefit from paper losses this year.
This is the first time we are filing taxes since having the LLC so we’re pretty green. I understand the basics - how the LLC isn’t a tax benefit and is just to protect our assets.
The following article by Amanda Han was excellent and helped answer 90% of my questions.
My only remaining question is this: If we show a 5,000 paper loss, will we each get to have 2,500 that we won’t have to pay taxes on? Is it that simple?
Couple questions -
1. Does the LLC own the properties ?
2. A two person llc is a partnership which changes the tax treatment slightly because generally a 1065 return needs to be filed. Then you would receive a K-1 from the return that would then be input on your personal 1040.
3. If you decided in the partnership to split everything 50-50 then yes that is how it should work. Some people decide to split things differently though because you need to have enough basis in the partnership to take "paper" losses generated from the partnership.
This is probably more than you wanted to know.
If the partnership (which is what the LLC will be treated as for US tax purposes) has a $5,000 loss when its taxable income is calculated, then assuming a straight 50/50 partnership across the board each partner will report a $2,500 loss on his or her individual tax return assuming you have sufficient tax basis in your respective partnership interests (something that you will need to calculate). The allocated loss should be reflected on the K-1 that you each should receive as partners from the partnership tax filing.
Not sure precisely what you mean when you say "we will each get to have $2,500 that we won't have to pay taxes on?" Are you implying that the $5,000 loss is specifically attributable to tax depreciation (i.e., a non cash expense)? If so, then yes you can have cash flow that is not immediately taxed because it is currently sheltered by tax depreciation taken.
You will each get a $2,500 loss on your K-1 from the LLC, but that does not necessary mean you will each recognize the $2,500 loss. There are numerous factors to take into consideration at the individual level:
3. Passive loss rules
A good CPA can help advise you how to make sure you recognize the full $2,500 loss on your 1040.
Thanks everyone for the responses! We just signed papers and closed on the triplex earlier today.
@Brett Sorenson Yes, everything is in the LLC's name, and we have split everything 50/50. My partner and I put exactly the same amount into an account to get started and we share responsibilities. I may put a little more time in, but that's because I really enjoy the work. What do you mean when you say we "need to have enough basis in the partnership"?
@Christopher Smith Our interests are 50/50. And yes, I am figuring the $5,000 loss will come from depreciation. Thanks for confirming!
@Lance Lvovsky Thank you. I am searching for a CPA now who will help me with this.