Income Property into LLC
In a recent Wall Street Journal article, an investor asked these questions: Is it true that if my spouse and I earned more than $150,000 per year in joint income, we can not deduct real estate loss from my taxes? If so, should I form a limited liability corporation and put my property in an LLC? How do I move my property into the LLC name?
The answer to the first question is complicated. There are many Internal Revenue Service rules and exceptions that affect the loss. An individual taxpayer who owns rental real estate, even if he or she actively participates in the management of these properties, is typically subject to passive- activity rules. Passive- activity rules restrict taking losses from rental real estate. Passive- activity losses are generally not deductible against other types of income such as wages, interest, dividends or most capital gains.
The average rental real estate investor often qualifies for one particular exception to the passive-activity rules. This exception allows individuals to deduct up to $25,000 ($12,500 if married but filing separate tax returns) of losses from real estate rental activities against all types of income (passive, active and portfolio). However, the $25,000 is reduced by 50% of the taxpayer’s adjusted gross income – the number at the bottom of page 1 of your 1040 federal income tax form – that exceeds $100,000 ($50,000 if married but filing separate returns).
By the time you reach $150,000 ($75,000 if married but filing separate returns) in adjusted gross income, there is no deduction remaining. It has been fully phased out and any disallowed losses are suspended and carried to future years. These losses may be deducted in future years if your adjusted gross income drops below the limits or you fully dispose of the rental activity.
You may qualify to fully deduct the rental losses under another, less restrictive exception. If the taxpayer qualifies as a “real estate professional,” then the losses from rental real estate aren’t treated as passive and aren’t subject to the passive restrictions at all.
To qualify for this exception, the taxpayer must pass two tests: More than 50% of the personal services per- (Continued on page 2) By the time you reach $150,000 in adjusted gross income there is no deduction remaining. Should formed by the taxpayer must be in real property trades or businesses, and the taxpayer must work more than 750 hours during the year – about 15 hours a week – in these same real estate businesses. Though 15 hours a week may not seem like much, the majority of the taxpayer’s efforts must be towards real estate activities. That is often the tougher hurdle to jump.
As for your other questions, moving the rental properties into an LLC or other business entity doesn’t allow you to bypass the passive-activity rules. What’s more, the $25,000 deduction for being an “active” owner – the person who approves new tenants, repairs and capital expenditures – applies to individuals only.
And if you still want to move the properties from your name into an LLC, consult a real estate attorney for details on transferring the mortgage and title.
If you are a small investor, these rules can be mind numbing. The trick is to have a plan in advance so you can take advantage of the tax laws that were designed to benefit you.
Under the exemption explained above, you must put in 15 hours per week in real property trades or business.
Develop your plan and work your plan, then talk to your C.P.M.® and implement your plan. The time you spend can make you wealthy.