Creating a secondary business

4 Replies

I am considering forming an LLC for landscaping and a second for construction. The thought being that it would create additional tax breaks when purchasing equipment etc that would be mainly used to maintain my properties. I believe that the companies can show a loss for up to three years before needing to turn a profit allowing me to write-off/amortize all of the equipment and expenses related to them then show nominal profits from them going forward. Is my though process correct or can I just include these expenses in the LLC that owns the property?

Thanks

"I believe that the companies can show a loss for up to three years before needing to turn a profit allowing me to write-off/amortize all of the equipment and expenses related to them then show nominal profits from them going forward."

You're referring to the "presumption" part of IRC Sec 183 that codifies an activity will be presumed to be engaged in for profit if during three out of any five year period gross income exceeds deductible expenses.  It does not allow you to write off up to three years of losses.  You're misinterpreting that part.

I also am not understanding why your real estate LLC can't buy the ordinary and necessary equipment needed to maintain the properties and take the write off. What does your CPA have to say on the matter?

You can just allocate the equipment costs to your rentals, no need to set up a separate entity. Just allocate in a reasonable manner across your properties.

If everything you do is real estate, there are only a couple reasons to set up a separate management type company. Generally it can be disadvantageous as this would create self employment income, where leaving the income in the rental it is not subject to self employment. The reason you may want to do it anyways is to create self employment income to take advantage of the deductions for self employed health insurance and some retirement plan types.

I will also note that an entity doesn't have to show a profit after 3 years to be a business - that is just one consideration in the facts and circumstances test. This particular rule was created to help rule out hobby losses, particularly horse racing. We have clients that have shown losses for way over 3 years straight where no way in heck you would call it a hobby. I have one entity 10 years strong of losing over several million a year, and they are convinced it is going to turn around, and it is run as a business - facts and circumstances, it's a business.  In the case of providing services to your other businesses, with losses many years straight would likely still be considered a business.

@Lucas A Riemens

Several separate issues are mixed together, so let's pull them apart

1. If you need equipment for managing your rentals, it is usually deductible against the rentals. No need to look for another place to deduct it.

2. (not brought up by you, but important) Sometimes, rental-related deductions (or resulting losses, to be more accurate) are limited regardless of equipment purchases, due to high income or high deductions or both. It's a separate conversation to have with your accountant.

3. You cannot deduct anything merely by forming an LLC. You need to actually start that other business (landscaping, construction or whatnot) and operate it for profit. Then you can deduct business expenses necessary for that specific business - and NOT for some other business like rentals. And then it can be done with or without an LLC just the same.

4. Starting a business for tax deductions is like opening a restaurant to eat. You start a business if you want to run this business and make money. Not trying to insult you by saying such trivial things, but it's an important point.

5. The "3 out of 5 rule" does not work the way you think it works. The rule says that if you make profit in 3 out of 5 years, the IRS will usually accept you taking losses in the other 2 years (provided you prove your expenses etc.) Otherwise, you can have losses for all 5 years or even 15 years, but then you will have to convince the IRS that you did try to make a profit all this time.

6. Small businesses with losses are the favorite IRS audit target, whether or not you make profit in other years. In contrast, having losses on the rental properties is normal and is not an audit flag by itself, barring other flags.

7. Sometimes, it does make sense to create a secondary business for tax reasons, for example a property management company. This is a more advanced topic and should be addressed one on one with your accountant.