Can I deduct passive RE losses if in an LLC?

3 Replies

I've followed all the threads about to LLC or not to LLC and most focus on the liability aspect. Since I only have two properties, I've kept them in my personal name so far and added an umbrella insurance policy just to keep things simple.

I procrastinated on our 2016 taxes and just finished them last night. My husband and I both have strong W2s and make more than $150k per year combined. We were unable to deduct any of our passive real estate losses against our W2 incomes. 

However, we also have a small ecommerce business that we started last year that showed a loss due to startup costs. That is in an LLC and we WERE able to deduct those losses.

If we were to put our properties in an LLC, would we be able to deduct the passive losses, even though it's still real estate?

@Kayla V.

The short answer is "no".

Placing your rental properties in an LLC does not change the characterization of the income they produce. Your current LLC business is a pass-through entity generating active losses. Active losses can be deducted against your other active income (like the income reported on your W2s).

Your rental income is passive, and so are the losses from rental activity. Placing the properties in an LLC does not change the losses from passive to active. They are still passive losses.

Above $150K passive losses are SUSPENDED. That means you can't take them in the current tax year. Make sure you keep track of them, you should be able to use them in the future.

Best of Luck on your Real Estate Investing!

@Paul Allen Thanks for the reply! 

That's what I figured, but was hopeful there was a way around it. Seems like other than becoming active in real estate per IRS rules, we're just stuck paying the taxes. 

Seems like other than becoming active in real estate per IRS rules, we're just stuck paying the taxes. 

 Yes, but you're more or less pre-paying them to get it refunded later. In the year you sell the property you can take all the suspended passive losses (for that property) no matter what your income level is. If you rack up $50K in passive losses between now and then you would get a very serious deduction in the year of the sale.

There can also be a bit of 'tax arbitrage' at play because the maximum rate on the "depreciation recapture" is 25%. If your top marginal rate is 33%, then you can deduct the racked up suspended passive losses (much of which is depreciation) at 33% and then repay the unrecaptured section 1250 gain ('depreciation recapture') at 25%.  You take money out of the pocket you'd pay 33% on and put it into a pocket you only pay 25% on - not such a bad deal. You just have to wait for it.

I find that keeping the long-term strategy in mind takes a bit of sting out of the current year's tax bill.

Best of Luck with your Real Estate Investing!

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