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Charles Markham
Charles Markham, Enrolled Agent
Category: Tax
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Experience:  IRS Enrolled Agent, US Tax Court Practitioner
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I will receive a rental property (gift) from my parents in

Customer Question

I will receive a rental property (gift) from my parents in June. The property is valued at $84,000. Once I have the propertyI plan to take a home equity loan in the amount of $60,000 and use the $60,000 to purchased another rental property.

Question: Can I deduct the interest that I am paying the bank on the $60,000 with regards XXXXX XXXXX taxes.
Submitted: 4 years ago.
Category: Tax
Expert:  Charles Markham replied 4 years ago.

TaxWhisperer :

You can deduct as mortgage interest associated with the new rental property.

TaxWhisperer :

You would make an "interest tracing" election. This would be the most beneficial way to handle it.

TaxWhisperer :

Hmmm...I am not sure if you could deduct such a mortgage against the original rental property. (I was thinking this was your home.)

TaxWhisperer :

I am going to opt out and let someone who knows this off the top of their head answer.

Charles Markham, Enrolled Agent
Category: Tax
Satisfied Customers: 653
Experience: IRS Enrolled Agent, US Tax Court Practitioner
Charles Markham and other Tax Specialists are ready to help you
Expert:  CGCPA replied 4 years ago.

Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

 

There is an issue regarding the use of mortgage interest in this case. However, there is an easy way to avoid this and it is one that protects your future as well. First form either an LLC or a corporation (with an S Corporation election to permit the losses to pass through to your personal returns. Then deed the first property to the new entity which you will own 100%. Using the first and second properties as collateral get a mortgage. Then the interest will be deductible within the entity and any rental gain/loss (subject to certain rules) can pass along to your personal tax returns. You gain the added value of the legal protection afforded to corporations and LLC entities. Either entity structure will work so you will need to determine which is less costly to form and keep. Here is some information from the IRS about the LLC. In my next post I will include information about the corporate structure.

 

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Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.

Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit "single member" LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state's requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.

Classifications

The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file a corporation, partnership or sole proprietorship tax return.

An LLC that is not automatically classified as a corporation can file Form 8832 to elect their business entity classification. A business with at least 2 members can choose to be classified as an association taxable as a corporation or a partnership, and a business entity with a single member can choose to be classified as either an association taxable as a corporation or disregarded as an entity separate from its owner, a "disregarded entity." Form 8832 is also filed to change the LLC's classification.

Effective Date of Election

The election to be taxed as the new entity will be in effect on the date the LLC enters on line 8 of Form 8832. However, if the LLC does not enter a date, the election will be in effect as of the form's filing date. The election cannot take place more than 75 days prior to the date that the LLC files Form 8832 and the LLC cannot make the election effective for a date that is more than 12 months after it files Form 8832. However, if the election is the "initial classification election," and not a request to change the entity classification, there is relief available for a late election (more than 75 days before the filing of the Form 8832).

References/Related Topics

Expert:  CGCPA replied 4 years ago.

S Corporations

S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.

To qualify for S corporation status, the corporation must meet the following requirements:

  • Be a domestic corporation
  • Have only allowable shareholders
    • including individuals, certain trust, and estates and
    • may not include partnerships, corporations or non-resident alien shareholders
  • Have no more than 100 shareholders
  • Have one class of stock
  • Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.

In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders.

Filing Requirements:

Chart 1 - S Corporation
id="tbl845id0_0" align="top" valign="top" scope="col">If you are an S corporation then you may be liable for...Use Form...Separate Instructions...
Income Tax

1120S (PDF)
1120S Sch. K-1 (PDF)

Instructions for Form 1120S (PDF)
Instructions for Form 1120S Sch. K-1 (PDF)

Estimated tax1120-W (PDF) (corporation only) and 8109Instructions for Form 1120-W (PDF)

Employment taxes:

 

941 (PDF) ( 943 (PDF) for farm employees)

940 (PDF)
8109

Instructions for Form 941 Employers QUARTERLY Federal Tax Return (PDF)

Instructions for Form 943 Employers Annual Federal Tax Return for Agricultural Employees (PDF)

Instructions for Form 940 Employers Annual Federal Unemployment (FUTA) Tax Return (PDF)

Excise TaxesRefer to the Excise Tax web page

 

 

Chart 2 - S Corporation Shareholders

If you are an S corporation
shareholder then you may be liable for...

Use Form...Separate Instructions...
Income Tax1040 and Schedule E (PDF)Instructions for Schedule E (Form 1040)Supplemental Income and Loss (PDF)
Estimated tax1040-ES (PDF)

 

References/Related Topics