Discussion:Rent paid by Sch C t/p for building owned by t/p
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Discussion Forum Index --> Tax Questions --> Rent paid by Sch C t/p for building owned by t/p
| 27 June 2007 | |
| My office-mate today stated he has a client with a Sched C business that rents space from his wholly-owned LLC at FMV. I told him that if the LLC is being treated as a disregarded entity the existence of the LLC is irrelevant and that the building should be accounted for as a depreciable asset on the Sch C, not as a Sch E property. He told me it happens all the time as a way to reduce SE tax. Now, a lot of things happen all the time that I don't know about (just ask my kids) but how can one claim rental expense on a Sch C for a building owned by the properietor? Am I just in the dark or is my office-mate wrong on this? | |
| 27 June 2007 | |
| If the client is careful to keep things businesslike - FMV rent, written rental agreement, etc., then this shouldn't be a problem. The guy is going to have to pay FMV rent to someone, right? | |
| 27 June 2007 | |
| This seems pretty sketchy to me if the goal is reducing SE tax. But I suppose one could argue there are substantive non-tax reasons for setting up the LLC to hold the property, and having the sole proprietor pay a FMV rent (e.g., taxpayer wants liability protection afforded by the LLC). I agree that it's kind of funky for a sole prop to pay rent to a disregarded entity on his or her own return. | |
| 27 June 2007 | |
| IRS does not allow this to reduce S/E tax, and I believe it's based upon Tax Court litigation finding there is no economic substance. Owning the property in an LLC, especially single-member or with family, should not make any difference. Any current litigation or Ruling to the contrary? | |
| 27 June 2007 | |
| Maybe the Sch C owner should make an SCorp election. Here's a link to a prior discussion: | |
Death&Taxes (talk|edits) said: | 27 June 2007 |
| Perhaps if it were his wife's 100% owned LLC it would work? Then again, arranging matters like this can blow up if the marriage collapses. | |
| 27 June 2007 | |
| Hi JD (ps how are you?) this is done all the time. An LLC disregarded enitiy is treated as owned by the individual tax wise reported on his sch E claiming rent from the C and deducting the interest and depr etc on the E. Especially if there are other tenants. We have had many arrangements like this for years. I also have clients who own the building/condo personally and we take all the related expenses on the C(only if no other tenants). Either way you are OK and either way you reduce S/E income. bye | |
| 27 June 2007 | |
| Why would a disregarded entity LLC allow a deduction that wouldn't be allowable between a Sch C and a Sch E normally? | |
| 27 June 2007 | |
| I, too, like the answer to Kevin's question - and cites. -- Larry Hess, CPA | Albuquerque, NM | Talk to me | |
| 27 June 2007 | |
| Hi, Wes. I'm doing well. I have consciously tried, however, to limit my time here because I have found myself wasting too much time here and preventing me from getting my paying stuff done. Kind of like crack, I guess. But I thought this issue might engender a good discussion.
Wes, are you saying you would not allow this for a Sch C if the building was owned personally, but only if the building is held in the LLC? It seems to me that the fact that the building is inside of an LLC is somewhat of a red herring because if the LLC is disregarded it should not impact the tax treatment of the transaction, as Kevin points out. And, while depreciating the building and charging the mortgage interest, taxes, etc to the Schedule C will reduce SE tax, what if the building is fully paid for and fully depreciated? In that case, rent expense on the Sch C will reduce SE tax a whole lot more than the building costs would. Beth, I certainly understand that this would work if the business was incorporated but I have a hard time seeing how it can be allowed for a Sole Prop. | |
| 27 June 2007 | |
| Remember, having your sole prop use your business real estate will probably make that real estate material participating ie: Profits are taxed for social security, Losses are suspended.
Hence the plan when correctly performed is tricky. Must meet all forms of the business, rents = fmv (and prove it), net from rental property close to zero. | |
| 27 June 2007 | |
| Since everyone is chiming in on this one I'll have a go, too. I cast a no-can-do vote. Since the LLC is a disregarded entity, its the same as a sole proprietor paying rent to himself. | |
| 27 June 2007 | |
| don't know if this will help but thought i would add it. Also I think everyone is chiming in that this method won't reduce SE but legal benefits may still make this a reasonable method.
Do a search for Florida Institute of Certified Public Accountants, FICPA Federal Taxation Committee, Subcommittee on Liaison With IRS, Questions & Responses for November 3, 2003, Meeting minutes. Q&A 14 is about company facilities owned by an S-corp shareholder, with a response from the IRS liaison (page 9 of 21). (Info that appears to be under copyright by another organization has been removed and replaced with enough info to allow other readers to find it if necessary, however see the next post first, and note the deleted info applies to S corps and not the Sch C in the OP.) | |
| 27 June 2007 | |
| Hadlin, that is only applicable to the question of passive activity income trying to offset passive activity losses. It still doesn't address the SE tax issue. | |
| 27 June 2007 | |
| Hi JD we have reported the building either on a sch E or C depending on the facts and circumstances regardless if held in a LLC or personally.I agree that form of holding doesnt influence the tax reporting for me. In fact today I found out one of my clients condo is in his SMLLC and we report all on his sch C. If paid off /depreciated correct the rent deduction gives you a better answer. I havent read all the passive losses etc because its a moot issue re your question. But I do agree the rent needs to be arms length. As always in life pigs get feed and hogs get slaughtered. My clients like most probably dont have documents "handy" but will be available upon request. I'm sure the next guy in line here will find fault in the real world but it is the real world we deal in with our clients. In 30 years of practice I have never heard this cannot be done. What if you own the building and have other tenants does one prorate your unit and the rest between C and E? In that case we put everything on the E. I have done it both ways E or C for a single occupied unit or building for clients.
I also have scaled back my participation on the cite. Altough its fun looking things up I found the day can go by quickly. best to you :) and as always bye. | |
| 27 June 2007 | |
| Chiming in to agree w/ Taxref word for word.
I think that the information provided by Hadlin applies to this situation, although perhaps not to the exact question at issue. If the structure is left as a rental, watch out for the recharacterization rules under 469. | |
Death&Taxes (talk|edits) said: | 27 June 2007 |
| Agree with JAD and the Ref too, except if the building were owned by spouse.
Twice now I have had client's 'Financial Planners' suggest this course to clients in Philadelphia. Usually I learn after the fact, and then I tell the client their SMLLC must acquire a $250 business license, a $30 a unit rental license, file a second set of business returns with the City, and file a Pennsylvania RCT-101. I love these guys who make fees for me! | |
| 27 June 2007 | |
| Hi does anyone out here have a cite that says this cannot be done? bye | |
| 27 June 2007 | |
| Wes, you don't expect us to support our positions and not just criticize, do you. LOL.
While I hate to cite Pubs as authorty, check out Pub 334 page 36 Rent. "Rent is the amount you pay for the use of property you do not own...If you have, or will receive equity in or title to the property, you cannot deduct the rent." | |
| 27 June 2007 | |
| Hi gotta go I will look at Pub. Who cares about a Publication without weight of law? How do you resolve multiple tenants? 30 years and never heard a peep on this issue leaves me shaking my head out the door. bye | |
| 27 June 2007 | |
| Easy for multiple tenants - just don't take a Sch C deduction for your portion of "rent", but still take the deduction for your portion of utilities, taxes, repairs, etc. Run the rest through Sch E.
Wes, the IRS just likes you. That's why they have never audited those returns you have done over the last 30 years. Doesn't mean it is right. If I run red lights for 30 years and never get caught (or killed), is it OK to tell others to run red lights? | |
| 28 June 2007 | |
| How's this Wes? IRC Section 162(a)(3) ordinary and necessary expenses include "...rentals or other payments required to be made as a condition to the continued use of possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity." Basically, you cannot deduct rent on something you own. Since the LLC is disregarded, the 100% owner of the LLC owns the property. Talk about a gimme adjustment for your friendly Revenue Agent. | |
| June 28, 2007 | |
| Yep, agree 100% no can do. Even if the wife owns it as I recall...Gotta inc. the Sch. C and then you're ok. I have/had one that escaped the audit period until we incorporated. | |
| 28 June 2007 | |
| Hi I cry uncle. But clearly "my" OINK shouldnt apply :). But seriously this issue I have never seen addressed before. Although my tax manager who had 15 years with KPMG did say he felt alittle uncomfortable about a shrink sch C paying rent on his condo unit. He never really mentioned it to me. Personally I dont feel uncomfortable going "one on one" with anyone out there or understanding the rules. But I also know enough to always give the other guy the benefit of the doubt. No one knows everything in that 2 inch thick IRC sitting behind my chair. WOW this really was an eye opener. bye
PS I know you guys know how humble I really am :) | |
Death&Taxes (talk|edits) said: | 28 June 2007 |
| JR: Regarding making payment to spouse, Check out http://findarticles.com/p/articles/mi_m6280/is_n4_176/ai_14240291 which deals with Cox vs. Comm TCM 1993-326 | |
| 28 June 2007 | |
| My understanding has always been renting to related parties is fine. | |
| 28 June 2007 | |
| Hey everyone, thanks for this discussion...Client was paying rent from his Sch C to LLC, which also had other renters. At end of last year, he acquired the other member's interest in the LLC and it became a SMLLC. I was pretty sure of how I was going to handle the change in structure but I hadn't committed. Love this forum. | |
| 28 June 2007 | |
| Well, everyone agrees except my office-mate who started this whole thing. Yesterday morning after posting this question the night before, he clarified his position that it only works if the building is owned by an LLC. Unlike Wes whose humility shines through as a bright star :), he is unwilling to agree that Sec 162(a)(3) applies if the building is owned by the LLC. (Actually, this morning before I pointed out this code section - thanks to Zornundo BTW for directing us all to the appropriate authority - he said he thought it might even work for a sole prop whose building was not in an LLC.) He says this tax planning strategy is routinely taught and RE tax planning seminars. As I began writing this response he just handed me, straight off Checkpoint/Ria a PPC discussion of the issue in the PPC 1040 Deskbook, Chapter 8, Key Issue 8C.
Recap: if separate property of spouse, the Cox strategy appears to be possible. But if SMLLC is SP, more of a gray area as need to show it's truly a separate legal entity, esp if property is jointly held. (Tim, I think quoting here with proper attribution does not violate fair use of copyrighted material. If it does, please leave the reference so people can look it up themselves - edited by Trillium: PPC copyrighted info removed and replaced w/recap, full reference still shows above. Also see NYSSCPA article on the Cox strategy, linked below.) Our discussion has centered around a Sch C renting from a wholly-owned LLC, but it seems to me if one would fly, the other would also. Okay, this has burned enough time for me. Thanks for everyone's input. Hopefully we've all learned something. | |
| 28 June 2007 | |
| But I have to follow up with 2 more comments...
(1) it is a disregarded entity for tax purposes, and that's the world that we are in. The LLC's status as a separate legal entity for legal purposes in my mind is not as important as its status as a disregarded entity for tax purposes. (2) I find PPC very helpful for its checklists, computational explanations of certain transactions, etc. I use it to orient to issues that I am not familiar with or where I am rusty. But be careful totally relying upon it. I have had several situations where PPC has been off-base and one huge almost disaster where it was dead wrong on a very material interpretation of a Reg. We all know that it is not authoritative. | |
Death&Taxes (talk|edits) said: | 28 June 2007 |
| The phrase 'a case could be made' surely should make the ears prick up.
I used to play chess, and in reading books masters would flog new ideas that 'have merit to take the game out of its usual channels.' And when I would use them, what would I find? Game's journey down the toilet bowl. | |
| 28 June 2007 | |
| But hopefully your read the disclaimer in the last sentence of PPC: "This is a gray area, so the practitioner should proceed with extreme caution and weigh the benefits versus the risk involved."
You pays your money, you takes your chances. I don't think there is anything authoritative on the issue. | |
- Another related article, re: Cox: NYSSCPA The Cox strategy: how to reduce taxes by renting from your spouse (1996).
