Rental Income vs Property Management Income

6 Replies

My investment partner and I will own a sfr property soon. it will be in an LLC owned by both of us. We will split the rental income equally. however the ten percent we budgeted for property management will go to me since I will manage the tenants. Will this ten percent be taxed as rental income or something else. how do I understand my options?

That 10% property management can be treated as Guaranteed Payments to partner. Guaranteed payment is a specific term in the Internal Revenue Code, which is defined as payments to a partner to a partner capacity for services or the use of capital if determined without regard to the income of the partnership.

Please let me know if you have any other question.

On top of the @Jay Patadia valuable insights, 

I wanted to clarify the SE tax on the payment that you will receive for the services because people tend to pay more taxes than they should on these payments. 

The payments you receive are not taxed as rental income for you when it passes through your personal return. First, on the partnership return, GP is a deduction for partnership (your LLC) against its rental income to arrive at its ordinary business income.

Second, when it comes to your return, generally, Guaranteed Payments (GP) from the partnership are subject to SE tax, but when the GP is for the services, as a general partner, to supervise the property shows and rents office space, perform the janitorial services (consist of cleaning the public entrances, exits, stairways and lobbies, collecting trash, and so forth) , collects the rents, deposits them in a checking account, and pay all expenses in connection with the management of the property, the GP you receive are not subject to SE tax. 

Although the payment might be not significant right now and does not impact much on your taxes, but might be significant later. And why pay taxes when you don't need to. 

However, where the services provided in such a situation include those for the occupants (e.g., housekeeping service), then the GP becomes subject to the SE tax.

Thanks so much @Jay Patadia and @Ashish Acharya !

I have been trying to pick between setting up an single member LLC to be paid for the property management in order to eventually have it taxed as an s-corp in order to minimize SE tax.

This GP is a new concept to me, so I'm grateful you brought it up. Can GP only apply to me as a 50/50 owner of the LLC, or can it also apply to me as a SMLLC who is providing pm services (that would fit the GP services described above)?

Anything else I should know? 

This is my first property, but I plan to rinse and repeat this strategy over and over again.  I would like to have it setup well in the beginning.

Originally posted by @Grant Shipman :

Thanks so much @Jay Patadia and @Ashish Acharya!

I have been trying to pick between setting up an single member LLC to be paid for the property management in order to eventually have it taxed as an s-corp in order to minimize SE tax.

This GP is a new concept to me, so I'm grateful you brought it up. Can GP only apply to me as a 50/50 owner of the LLC, or can it also apply to me as a SMLLC who is providing pm services (that would fit the GP services described above)?

Anything else I should know? 

This is my first property, but I plan to rinse and repeat this strategy over and over again.  I would like to have it setup well in the beginning.

If you are not in the business of PM, than I would not create LLC for Property management to be taxed as S-corp. You are already not Paying SE tax on the GP for property management.

if you create an LLC just to manage the property and get paid for that via LLC, the income is taxed for SE since LLC is in the business of PM. You can argue that you can elect S-crop to avoid SE tax, but you gotta first pay a reasonable salary to your self and that is subject to SE tax. If you had employees and had huge income from the property management, then that would be a different story, but for few houses that you manage, in a partner capacity, you get the same benefit without the LLC.

And GP is paid to partners. If you create SMLLC to manage a property, the SMLLC is a vendor of the rental business, not the partner, so there are no GP treatments. The money you pay to you PM LLC will be income subject to SE tax and business expense to the rental business's partnership.

@Jay Patadia & @Ashish Acharya

Thanks so much for the feedback so far.  MyCPA sent me this as a short answer and said he would follow up with more information.  Do you have any feedback on what he's told me so far?  I just started with him as my CPA, so I'm still in the vetting process. 

"The short answer is that your references are partially correct, with a loose interpretation of Code Section 707 and a court case (Pratt Vs Commissioner from 1975).  It's a gray area and the IRS specifically disagrees with not calculating SE tax on any Guaranteed Payments." 

Originally posted by @Grant Shipman :

@Jay Patadia & @Ashish Acharya

Thanks so much for the feedback so far.  MyCPA sent me this as a short answer and said he would follow up with more information.  Do you have any feedback on what he's told me so far?  I just started with him as my CPA, so I'm still in the vetting process. 

"The short answer is that your references are partially correct, with a loose interpretation of Code Section 707 and a court case (Pratt Vs Commissioner from 1975).  It's a gray area and the IRS specifically disagrees with not calculating SE tax on any Guaranteed Payments." 

 
Grant, Please suggest your CPA to look at Rev. Rul. 64-220. 

And yes GP is generally subject to SE but this Rev Rul tells you that GP is not subject to SE if you just supervise the property as I have mentioned above. 

Hope that helps. 

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