Tax Implications of Separating Real estate from Business LLC

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Tax Implications of Separating Real estate from Business LLC

Billie Joe
Member since 2019 · 10 posts · 0 votes

My mother and I purchased a rental property last year, we are 50/50 owners. We paid cash for property at 22k, put some work and money into it, and it's been valued by the auditor at around 45k before improvements (however hasn't been officially appraised). We were looking at a couple of options for the the rental:

A. Put property into LLC 1 and manage the property with LLC 2 in the same state.

B. Put property AND Management in 1 LLC, which would be owned by a Wyoming LLC

Either option would be for protection of assets.

Question:

What are tax implications of putting the property into 1 LLC and Putting the property mgt (financial portion) into another LLC? I'm assuming we wouldn't be able to lower our tax liability by claiming depreciation on the property since the LLCs would be separate, but would we even need to? Could that create a negative impact on the taxes for the 2nd LLC (Property Mgt. side)? Am I missing something?

Put more simply: On the tax side of things, would it be better to put everything into 1 LLC or separate the asset by forming another LLC for the Management Side?

Further Details that may be pertinent: We are planning to file as an S-corp, with me managing the property and her receiving the distribution portion. 

We are both reasonably low income and the business only net profits around 7,500 per year, so since I have dependents to claim, the self-employment tax would not negatively affect me right now, and since my mother is retirement age, that scenario seems like the best option. 

It is also my understanding that any money that goes into an LLC (taxed as S-Corp), would not be taxed until it is paid out to its members (me or mom). Is that correct?

Thank you in advance to anyone who is willing to share your wisdom and experience! 

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Billie Joe

    A lot of questions here...I'll answer a few in a general sense but it's really advisable to engage a tax CPA/EA who understands your facts, circumstances, and goals.

    "It is also my understanding that any money that goes into an LLC (taxed as S-Corp), would not be taxed until it is paid out to its members (me or mom). Is that correct?"

    No, you're thinking of a C Corp.  An S Corp is a passthrough entity.

    "Further Details that may be pertinent: We are planning to file as an S-corp, with me managing the property and her receiving the distribution portion."

    Are you thinking of putting the real estate asset in an S Corp?  Generally this is not advisable.  Putting appreciating assets inside of a corporate tax entity, whether S or C, should be avoided if possible.

    Are you aware you may be converting income not subject to self-employment taxes to income subject to self-employment taxes by creating an S Corp to manage your own personal rentals?

    The structure you're proposing looks good on paper but is more likely than not to materially decrease your ROI because you're substantially increasing administrative and tax overhead.

    Old military acronym applies to real estate investing when just starting out: K.I.S.S.

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  • Billie Joe
    OP
    Member since 2019 · 10 posts · 0 votes
    7y

    @Eamonn McElroy Thanks for your reply!

    That's good to know about it not being advisable to have assets in an S Corp. I will look into that further. 

    Yes, I'm aware that I would be subjecting myself to self-employment tax, which, to my understanding, would be offset by being single, having dependents, and not having a large amount of earned income personally. Once that changes is when we would revisit the operating structure. To keep from having to complicate things by employing myself, I was going go the 1099 route-- Do you see any possible issues with that?

    So, are you saying that there may be more tax liability by having an asset and the business together in the S-corp, as opposed to separating the asset and the business in 2 separate LLCs?

    I have spoken to some CPAs and attorneys, and they have given me some good advice, but at the same time, seemed a bit unfamiliar with my particular situation (our situation is kind of an anomaly), but based on what we discussed, this appears to be the way to go (for now at least). 

    The last missing piece to the puzzle is the difference in tax liabilities between having the asset and business together (in the same LLC) or separate LLCs. 

    @Eamonn McElroy

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  • Billie Joe
    OP
    Member since 2019 · 10 posts · 0 votes
    7y

    By the way, you're right Mr. McElroy- but you already knew that. lol.  Upon looking further into the scenario, the necessity of payroll, quarterly reporting, and the more expensive and lengthy (1120) return with the S corp is enough to turn me toward just being taxed as a partnership and keeping it simple for now, especially since the business has very little income. I had no idea that all of these additional things would come with being taxes as an Scorp. Most people focus on the advantages for businesses with 30k or more in income-- and that's not us. 

    Still the missing piece to the puzzle is finding out why I should or should not own assets in the same LLC as the business.

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  • Mike S.
    Investor · Broward County, FL · Member since 2018 · 1k+ posts · 938 votes
    7y

    The setup I am using is as follow:

    each property is in its own land trust, each land trust has as beneficiaty, a single member LLC in the same state.

    Each single member LLC is owned by a multi member WY holding LLC.

    I have a C corp as property management for all my properties.

    This structure is probably way too expensive in your case for a single property but let me explain the main reasons of this setup.

    land trust: create anonymity and some liability protection (only in FL).

    single member LLC: create the inside liability protection for each property, avoiding propagation of liability to the other assets. It is disregarded by the IRS (ie no filing) but some State may need their own filing.

    WY holding LLC: owns all the sub LLCs. create the outside liability protection through the WY charging order.

    C corp: get all the fringe benefit available from C Corp. The company charge only enough money to cover the costs and make a little profit. I am not taking any money out of it.

    In your situation, I don't know in which state you are, but if your state LLC protection are good enough, you could only have one multi-member LLC in the state that does everything (ownership and management). Your LLC will have to file a 1065 informational report each year and distribute K1 to its members, but as a whole it should be tax neutral for you.

    I would suggest that you consult a real estate asset protection attorney and CPA that could guide you through the different options so you can make an informed decision.

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  • Billie Joe
    OP
    Member since 2019 · 10 posts · 0 votes
    7y

    @Mike S.

    Thanks for sharing your insight and your setup! We are in Ohio. We are able to do an anonymous LLC, but not with the same charging order protection as the Wyoming LLC.

    You're right about your structure being too much for what we have, but it's definitely something to consider in the future as we grow, so thank you for that! We don't have much, but what we do have is paid for, so we want to protect it the best we can, without going overboard.

    I think we're going to just leave it taxed as partnership for now. It would be a Manager managed LLC, with me being the designated manager. - Designating myself as a 1099 contractor for the business. I believe that whether I'm a partner or contractor, I'd be taxed the same.... and yes, I believe you're right about it being tax neutral.

    Since you have each property in it's own LLC, do you capitalize each LLC?

    I'm also a little confused as to how the 2 LLCs would be connected....So, if you have an LLC that's owned by another LLC (parent umbrella LLC), does that mean you have to register as a foreign entity? or does that mean that you have 2 separate entities, and one just owns the other? or 2 separate entities, and one works for the other? or does that mean, one is made to be a partner or manager inside of the other? It almost seems as if all of these are options, but each would mean something different.

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