Discussion:Rental Income/Expenses: Can LLC report these if they do not own the property or mortgage?
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Discussion Forum Index --> Tax Questions --> Rental Income/Expenses: Can LLC report these if they do not own the property or mortgage?
NorthernEA (talk|edits) said: | 30 May 2006 |
| Hi there. I am trying to help my client out of a mess. In 2005, they bought a house and turned it into a rental. They also formed an LLC (to be taxed as a partnership) with two other people. They took money from a refinance of another rental to contribute to the LLC. However, they decided that the new rental would be the LLC income and expenses without transferring title or debt to the LLC. The CPA who did the LLC tax return reported the income and expenses (including depreciation) of this rental on the partnership tax return, passing on a rental loss to my client. (The other partners cannot deduct any loss as they made no contribution to the partnership) Can the LLC assume income and expenses for property it does not own, is not legally liable for, and has no true debtor-creditor relationship? I say that my client must report the income and expenses on his tax return on Schedule E and that the LLC had no income or rental related expenses. The fact that the checks were written by the LLC for the mortgage (interest only loan) and the taxes makes it complicated as to who can actually claim these expenses. I don't know how to help my clients out of this mess and I am confused as to why the CPA would report the rental income and expenses on the LLC tax return. He said that this is common and he does it all the time. Please help. Have any of you run across this? If so, where can I find verification that it is OK for the LLC to take the income and expenses, including depreciation, for a property that it does not own. (Everything I am reading says no, they can't). Thanks to anyone who can discuss this with me. | |
| 30 May 2006 | |
| If the LLC is the equitable owner of rental property, it should report income and deductions from the property -- even though legal title is vested in another person. | |
NorthernEA (talk|edits) said: | 1 June 2006 |
| Riley2 - what do you mean by "equitable owner"? | |
NorthernEA (talk|edits) said: | 1 June 2006 |
| Does anyone else know what Riley means as "equitable power" or have any other ideas on this topic? I would love to get this return completed, but I must resolve this issue. Are there any other tax professionals who handle this type of situation and if so, how do you handle it? Do you take the income and expenses on the partnership return even though the LLC has no legal title nor is liable for the mortgage? If yes, have you ever been audited regarding this? I called the IRS technical line on partnerships and they say that a business entity cannot take deductions for property which it does not own, but then, I know that they aren't going to do the research to find out if there are exceptions or circumstances which would allow the business to take the deductions. Please help, if you can. Thank you. | |
| 1 June 2006 | |
| Equitable owner just means that it's acting as the owner, despite title difference. Very common situation is a client who buys a vehicle in their personal name, yet for all intents and purposes it's treated as a corp. vehicle. We don't care about the title. That's what he's suggesting is the case here, so the proper treatment is to treat it as LLC property. | |
NorthernEA (talk|edits) said: | 1 June 2006 |
| Doesn't the property ever have to be transferred into the name of the LLC? How does the limited liability of an LLC apply when the LLC has no legal ownership? If there was a law suit, wouldn't my client be liable and not the LLC? Also, regarding the partnership return, is the property considered an amount of asset and debt transferred to the LLC for purposes of basis? | |
| 2 June 2006 | |
| Agreed, they're on pretty thin legal ground in event of suit, which kind of defeats the point of the LLC. Tax reporting is another issue, tho'. Same is true of that vehicle owned personally, in the event of suit. | |
| 2 June 2006 | |
| The concept of equitable ownership is well-established. The problem is that should it be challenged by the IRS your client would probably have to go to court. He would need to prove to the court that the standards for equitable ownership are met; the court would decide based on the facts and circumstances. That makes equitable ownership a gamble, not to mention all the problems which can come up in regards to financing, selling, etc. | |
NorthernEA (talk|edits) said: | 5 June 2006 |
| Thank you to those who have responded to this topic. I feel somewhat validated in my concerns for my client. I have asked the CPA who did the partnership return to give me any guidance as to why he does this routinely for his LLC clients, but have heard nothing back - no surprise. I have also contacted my client and expressed my concerns and asked him to consider carefully the purpose of the LLC and the legal consequences of reporting the rental on the LLC partnership tax return. Sadly, it is difficult sometimes to do what is in the best interest of the client when they are determined to do something opposite of what you recommend. (They would really lose out on 1/2 of the loss on their return as the loss has to be split among the partners.) I am just about ready to wash my hands of this client as the issues in future years will be progressively worse. Again, thanks for the comments. | |
| 5 June 2006 | |
| This is just my personal opinion, but I wouldn't get rid of the client just because of this issue. Unhappily, clients with improper legal titles to real estate, cars, etc., are a common problem for accountants. If they refuse to heed your advice, I would write a letter to the clients now (and another one each time you do the annual tax return)telling of your concerns and the possible problems which can arise. Be careful to keep copies in their file. If they choose to disregard your advice, you then have backup documents in case of difficulties. | |
| 5 June 2006 | |
| The tax definition of an equitable owner is someone who has assumed the benefits and burdens of property ownership, including the risk of loss, the obligation to insure the property, the ability to acquire title by simply demanding such from the titleholder, and the ability to sell or improve the property without the consent of any other person. Implicit in this definition is the possession of the legal right to retain the sales proceeds in the event of a sale of the property. | |
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