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My husband and I are the sole member managers of an LLC which

owns a condominium in the...
My husband and I are the sole member managers of an LLC which owns a condominium in the town where our kids go to college. (It is titled to the LLC and the mortgage is in the LLC's name with us as "guarantors") Currently, our son lives there with a roommate. The roommate pays FMR rent for half of an apartment (e.g. market rate is $900, he pays $450). They were both there for the same number of days.
Here's what I think I know:
If we owned this property directly, rather than through the LLC, I would allocate 50% of (1) mortgage interest, real estate taxes, (2) direct rental expenses, (3) expenses directly related to operating or maintaining the dwelling unit, and (4) depreciation, in that order and deduct these on Schedule E of our joint federal income tax return to the extent they didn't exceed my rents collected. I could then deduct the other 50% of mortgage interest and real estate taxes ONLY (no other sorts of expenses) on Schedule A as a second home.

If that is correct, here's my question: Do I handle it roughly the same way for the LLC. Meaning deduct 50% of expenses enumerated above against gross rents on form 8825, and then pass that rental real estate income on to schedules K & K-1, which I would then report on the second page of schedule E. (This passthrough value will be a zero as 50% of expenses exceeds my gross rent receipts.) Then deduct the other 50% of mortgage interest and real estate taxes only on Schedule A as a second home?

How do I treat additional expenses? For instance, legal expenses for setting up the LLC? What about the cost of a P.O. box I maintain only for the use of the business? Are they "ordinary and necessary rental real estate expenses" that should be deducted on form 8825 or are they instead "other deductions" that would be entered on line 20 of Form 1065?
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Answered in 4 minutes by:
4/15/2013
Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,244
Experience: Extensive Experience with Tax, Financial & Estate Issues
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Stephen G :

Hi & thanks for using our service. I'll do my best to give you a complete & accurate answer. Please ask me to clarify anything that is not clear.

Stephen G :

When did you form the LLC and when did you purchase the condominium?

Customer:

We formed the LLC on 7/24/2012 and purchased the condo on 7/27/2012

Stephen G :

ok

Stephen G :

So at this point you are planning on filing a partnership tax return for the LLC because you have 2 owners?

Stephen G :

?

Customer:

Yes, that's correct. As I understand it we cannot be a qualified joint venture because we are incorporated as an LLC. (We've been part of LLC's in the past, but not for real estate so I'm struggling to reconcile what I know about LLCs with real estate.)

Stephen G :

The problem you have is you have set up an entity that is separate from you personally but only 1/2 is being used for business; so technically everything should be paid out of the partnership/LLC, which means that you should be transferring funds into the LLC/Partnership to cover the expenses and whatever amounts are allocate to personal use (second home) should be charged to your draw accounts.

Stephen G :

OK, you aren't "incorporated" as an LLC, you are "organized" as an LLC (not to confuse the option of the LLC to file as a corporation).

Stephen G :

However, the way you describe what you are suggesting, is more like you are only going to include that portion of the LLC that is business in the partnership; that is also an option;

Stephen G :

The way you are hanling things that might be easier for you;

Stephen G :

If you were dealing with a second home exclusively, there would be no need to form a partnership in addition to the LLC just to deduct the mortgage interest and real estate taxes;

Stephen G :

Is your income too high to use the 25K rental real estate loss allowance?

Customer:

We are transferring funds into the LLC/partnership to pay expenses (otherwise there'd be no way to pay them, as they exceed rent taken in!) But I don't know how to do the accounting re: draw accounts. The model I was using was the situation in which you rent out a room of your home and use that percentage against expenses, it seemed simpler.

Stephen G :

Sure, except the home isn't in a partnership.

Stephen G :

When you transfer money in, that's an addition to your capital accounts - 50 - 50

Stephen G :

When you have non-deductible expenses, those would be debits to your draw accounts;

Customer:

we are probably in the phase-out portion of the rental real estate loss allowance, I think we'll squeak in under the cutoff.

Stephen G :

If I were doing the bookkeeping, I'd just make an adjusting entry at the end of the year to credit all the expense accounts for 50% of the balance and then debit the draw accounts as the offset; then on my personal return I would just take the real estate taxes and interest as schedule a deductions; on the partnership return, I'd just show 1 number reducing the expenses as something like "less 50% of expenditures allocated to personal use"..........to make the bookkeeping so much simpler.

Stephen G :

when I say all the expense accounts, I mean in total

Stephen G :

not each account

Stephen G :

Does that make any sense or did I lose you in Accounting 101

Customer:

Ok, that's more or less what I was thinking. A little lost in Accounting 101, but I can probably pull out my LLC accounting book and review that. But to recap, in terms of taxes I think you are suggesting: File partnership return using 50% of expenses (this will be capped at the amount of my gross rental receipts because the IRS says that "if a property that qualifies as a personal resident is rented for more than 15 days, the deduction of expenses related to the property is limited to the amount of rental income recieved during the tax year and there is an ordering of the allowable deductions". But I can deduct the 50% of mortgage interest and real estate tax for personal use on schedule A. Is that what you meant?

Stephen G :

No.

Stephen G :

The 1/2 of the Condo rented to the roommate does not qualify as a personal residence; that is 100% business.

Stephen G :

You treat it as if it was a duplex

Stephen G :

You are reading the vacation home rules; where there is rental usage and personal usage;

Stephen G :

If the roommate's 50% usage generates a loss then you would come under the 25K or phase out of that number which applies;

Stephen G :

Your son's 50% qualifies as a second home as long as he's in school; or later not working (perish that thought).

Customer:

So then expenses will halved and allocated half to "each unit," one of which will be for personal use and one as a rental? (If so then I allocate 50% of the depreciation to that "unit" also?) Then I report the loss on that "unit," passing it through on K-1 and treat my son's unit as a second home, deducting the mortgage interest and real estate taxes for that "unit". Will this mess me up in future years if I rent the whole thing or none of it (I have 3 kids in college come fall, g-d help me!)

Stephen G :

It won't mess you up as long as I stay alive to remember what I told you to do :]. Sorry its been a long day............if it messes you up, we'll unmess it if necessary; no problem; as a matter of fact it should make it easier if you change the usage; how are you going to convince them all to go to the same college?

Customer:

We convinced them to go to the same college by telling them that's what we'd pay for, and buying them a (cute if kind of old) condo to live in. Told them they could go wherever they wanted for grad school (when they're paying for it themselves). I've worked at a private college consultant for several years and have become increasingly convinced that choice of undergrad school isn't very crucial for most kids...though most of my clients send their kids to private schools or "big-name" publics, the reality is that private colleges are crushingly expensive for most of the upper middle class--no financial aid, but big bills to pay. We don't qualify for any real financial aid even with three in college!

Stephen G :

You should have had Rhodes Scholars. UMIAMI here, 3K a year, including room & board and Northeastern was the same; of course that was before you were born...............

Stephen G :

Those were the days when a college education was worth something, now, I'm not so sure; I wish I was a caddy on the pro golf tour...................

Customer:

It's ugly now, hard to explain to parents who went to private universities or out-of-state schools themselves that Higher Ed costs have spiraled relative to everything else. A college degree is still worth something--at least you're more likely to be/stay employed, as the high-paying blue collar jobs are virtually gone, but I think that if a kid/family can get a degree locally without debt it is the only choice that really makes any sense. We're in Colorado, with relatively cheap state schools, but pay about $18K year for tuition and room and board (that's about what my husband and I paid for PA in-state in the 80s) . But privates and expensive state schools are running $40-60K, which is insane.

Customer:

Is there a way to find you again if I have additional questions?

Stephen G :

Yup, funny you should ask; I'll leave my contact info here;

Stephen G :

you all set for now; filing on extension I presume?

Stephen G :


If you need to contact me again with any tax or financial questions, you can just ask for "Steve G" at the beginning of your question. Again, please remember to rate my response. Bonuses, where you think they are warranted, and excellent ratings, are always most appreciated. Thanks again for using JustAnswer.com.

You may get a short survey from the site; if it isn't too much trouble I would appreciate it if you would answer it; the survey results are used to rate our performance;


Thanks very much, Steve G.

Customer:

I wanted to finish today, and could probably be done by midnight, but I understand that it's a bit "safer" (less likely to be audited) to file on paper, and I won't get done before the post office closes, so I guess it's an extension for me. (I seem to need 1 extra day every year, though I start a day earlier each year too! Gonna have to get my act together in March next year, I guess--or bite the bullet and hire a CPA again, although I gave that up because I kept finding errors in the returns they sent me!)

Stephen G :

It's that Rocky Mountain High they're all on..................

Customer:

HA! I'll be happy to fill out a survey, and really appreciate the help.

Customer:

Thanks.

Stephen G :

ok, good luck, I'll be around, a little sleepy, but around

Stephen G :

remember to rate my response >00<

Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,244
Experience: Extensive Experience with Tax, Financial & Estate Issues
Verified
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Category: Tax
Satisfied Customers: 7,244
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