Real estate professional tax benefits and LLC structure?

14 Replies

My husband and I own rental property together, we are both on the deed. My husband qualifies as a real estate professional for tax purposes. We want to use that to offset my income, as I am the higher earner (I have a regular job). Our CPA set up an LLC for our rental property but he says it needs to be in my husbands name (single owner llc) in order for the losses to offset my income. We can't have it as a partnership LLC, for example. Apparently this is how it works.

We want to eventually transfer the property into the LLC. The issue is that doing so would make my husband the sole owner of the rental property. He would be the sole owner of the LLC, which then owns the property, essentially.

This is not what we want. How do I keep my part of the ownership of the property while still benefiting from my husband's RE tax professional status? 

Originally posted by @Yinna Wang :

My husband and I own rental property together, we are both on the deed. My husband qualifies as a real estate professional for tax purposes. We want to use that to offset my income, as I am the higher earner (I have a regular job). Our CPA set up an LLC for our rental property but he says it needs to be in my husbands name (single owner llc) in order for the losses to offset my income. We can't have it as a partnership LLC, for example. Apparently this is how it works.

We want to eventually transfer the property into the LLC. The issue is that doing so would make my husband the sole owner of the rental property. He would be the sole owner of the LLC, which then owns the property, essentially.

This is not what we want. How do I keep my part of the ownership of the property while still benefiting from my husband's RE tax professional status? 

Your CPA is not correct. 

Husbands and wife are one economic unit when taxed as jointly filers. The Rental loss, if allowed, should offset your high W-2 income. 

LLC is not required for tax purpose. It's more for legal purpose.

 

Thanks for replying @ashishacharya 

Is it possible it's different in New Jersey? We do file jointly, but apparently if we own the LLC as a partnership, then I would also have to qualify as a real estate professional. Last year I filed as active participant, which only offset 25k, and left the bulk of my income subject to self employment tax.

@Yinna Wang

"Is it possible it's different in New Jersey?"

We're talking federal law here -- the treatment is the same for everyone in the US regardless of if you're in NJ or Barrow, AK, or Topeka, KS.

Treasury Reg §1.469-9(c)(4) dictates that if one spouse is an RE pro, both are considered RE pros for the passive activity loss rules if filing a join return.  Material participation by one spouse is attributed to the other for purposes of the passive activity loss rules under Treasury Reg §1.469-5T(f)(3).

Agree with Ashish, it seems your CPA is mistaken.  Or -- there's something going on that we're not told and don't see (trying to give him the benefit of the doubt here).

Perhaps your CPA considers the LLC two separate "activities" for the passive activity loss rules. This would be a mistake, you fundamentally only have one "activity" even though there are two members in the LLC. Time to go back to your CPA with the hard questions...

I'll agree that your CPA is incorrect. While not explicitly stated in the tax code that I am aware of, this has gone to court several times in the favor of the taxpayer. Tell your CPA to look up Fitch v. Commissioner and the resulting TC Memo 2012-58 - in that case each spouse held properties in their own named, filed a joint return, only one was a qualified real estate professional, and all losses were allowed 

Here to also agree that your CPA is incorrect. 

The properties can be in a partnership if that's your goal- keep in mind you're generating another tax filing/expense by having a partnership. 

You may be able to accomplish the same goal by holding the properties in single member LLCs with only one of your names on them - they're disregarded federally so the rentals would still report right on your 1040 return. I'd discuss with your attorney. 

Additionally, RE pro is something the IRS looks at- I'd make sure your logs and how it's being tracked/recorded is up to par too. 

@Yinna Wang

It appears that as an "active participant" you qualified for the special election by filling out form 8582. You probably made $100k or less total to take advantage of the full $25k PAL (Passive Activity Loss) against ordinary income.

Because your husband qualifies as a real estate professional, your PALs should not be limited in offsetting your ordinary income in any given year that he maintains that status. 

As @Natalie Kolodij mentions, make sure your documentation for Real Estate Professional is kept track of in case of an audit. 

Perform a reasonableness check to determine whether you should or shouldn't get an LLC at this time. If you don't have significant personal assets or equity in the house, usually it makes sense to just operate on a schedule E. Just a reminder if you do operate an LLC to make sure it is operated as a separate business so that no one can "pierce the corporate veil" otherwise you may as well not have an LLC election at all. Example to protect you include: separate business and credit card accounts, expenses paid for on behalf of the business are properly reimbursed back to you, you don't use the business to pay for personal items without proper documentation and reimbursement (classifying it as a loan from the business), etc.

Thanks for all the responses.

I'm setting up a call with my CPA, will update. In the meantime, does anyone know (or is yourself) a good Real Estate Attorney, preferably in the north new jersey area?

Originally posted by @Yinna Wang :

Thanks for all the responses.

I'm setting up a call with my CPA, will update. In the meantime, does anyone know (or is yourself) a good Real Estate Attorney, preferably in the north new jersey area?

I have a couple of contacts feel free to DM me.

 

Ok, update. First, I'd like to mention this is a house hacking scenario. We are doing our diligence in filing only the losses/gains of the rental portion of the property. Is there anything about this that would change the way the taxes were done?

Second, my income was 1099 income, meaning it is subject to self employment tax. I was told this was reported on Schedule C, and regardless of how much bottom line income I report, I still need to pay this tax on my earnings. 

Given these two issues, and the fact that our LLC was partnership 50/50, my CPA didn't think my spouses's real estate professional status could help offset my income. They offset my spouse's, but not mine.

@Yinna Wang

"Ok, update. First, I'd like to mention this is a house hacking scenario. We are doing our diligence in filing only the losses/gains of the rental portion of the property. Is there anything about this that would change the way the taxes were done?"

Are you renting out rooms in your residence or are we talking clearly separated units (e.g. duplex, triplex, etc)?

"I was told this was reported on Schedule C, and regardless of how much bottom line income I report, I still need to pay this tax on my earnings."

Taxable income for self-employment taxes and taxable income for income taxes are two separate numbers.  Rental losses can't reduce the former but can reduce the latter.

"Given these two issues, and the fact that our LLC was partnership 50/50, my CPA didn't think my spouses's real estate professional status could help offset my income. They offset my spouse's, but not mine."

I'm beginning to suspect your CPA doesn't have a good (or even fair) grasp of the passive activity loss rules...

@Eamonn McElroy Thanks, gonna go with your reply format bc I like it. 

"Are you renting out rooms in your residence or are we talking clearly separated units (e.g. duplex, triplex, etc)?"

Clearly separated units. It's a fourplex, so we're going with 75/25 with the losses.

"Taxable income for self-employment taxes and taxable income for income taxes are two separate numbers. Rental losses can't reduce the former but can reduce the latter."

This is what my CPA said. I told him to run the numbers anyway.

There's also some concern that being a licensed re agent, owning half of a general contracting company, managing sub contractors and DIY-ing lot of the renovations, managing tenants, finances, and property management, somehow don't add up to a real estate professional status. 

If the IRS were to look into this, what kind of proof or documentation would they accept? 

Also, how does my material participation fit into this as well? I owned the other half of the general contracting company and did everything he did, just don't have a re license. 

@Yinna Wang

Contemporaneous records aren't required for RE pro designation -- but -- the better records you have the more of an argument you have in the eyes of the IRS and tax courts.  Tax courts have sided with individuals based on oral testimony of their weekly activities.  Contemporaneous logs, calendars, etc will be more than sufficient.

If your husband is an RE pro and materially participates in the rental activity your participation won't matter.  See my first post.

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