Avoinding SE tax using a Limited PS

[dsi]

What am I not understanding? For years I have reported my client's vacation rental cabins on his 1040, Sch C. Last year, another CPA convinced my client to form a Limited PS, making my client a 1% General Partner, his daughter a 1% Limited Partner, and my client's living trust a 98% Limited Partner.

So, at the end of 2008 my client received two K-1's....one for him as the 1% general partner, and one for him (but titled the DG Living Trust) as the 98% Limited Partner. Keep in mind that my client is still living so the trust is reported in his SS#.

Does this setup avoid the SE tax?

[Burke]

Not in my opinion. The living trust is a disregarded entity and everything passes thru to the TP. The only thing it does is avoid probate. Not taxes or tax rules. You still do a Sche C. 99% goes on TP's return, 1% to daughter as passive income.

[BHoffman]

Agree with Burke. Did the client pay a very hefty fee to have this arrangement set up?

[Zee]

I guess I'm also missing something. Why would you report rental income on a Schedule C instead of a Schedule E, unless maybe this is a business like a fish camp, etc?

[Burke]

If he qualifies as a real estate professional.

[Zee]

If he qualifies as a real estate professional.

Yes, then he'd be in the "business". Or, I suppose someone with several cabins renting boats and managing or with an on-site manager would also be a Schedule C.

I would agree that the living trust only offers a potential savings by avoiding probate.

Maybe the original poster will explain why he prepared a Schedule C in prior years?

[joanmcq]

when he said rental cabins, I imagined a rustic hotel.

[dsi]

He has several cabins that he rents out to vacationers during the year. They are rented out by the day, and sometimes for the week. i.e., a group of snow skiers from Southern CA want to come up the the area and spend a week skiing. They would rent one of his cabins for the week. All rentals are short term. This is a Sch C activity, not E.

[Burke]

I have a client who has a couple of properties in a resort area in another state that he rents out to vacationers, and in which he materially participates (i.e, has website, books all renters himself, etc.) but it is considered a passive activity, Sche E. He is now retired, but had these when he was locally employed full time.

[dsi]

This client has a management company handle all of the bookkeepings, collection of cash, etc. So he doesn't really participate, except for perhaps making the big decisions on repairs.

[Zee]

This client has a management company handle all of the bookkeepings, collection of cash, etc. So he doesn't really participate, except for perhaps making the big decisions on repairs.

How many is "several" cabins?

If a client has an apartment building with several apartments and a manager, does that make it a business as opposed to rental property?

I don't think so, but it's an interesting question...isn't it?

According to IRS Pub 527. The only time you would report rental properties as a business (on the Schedule C), and therefore subject to self-employment tax (but also eligible for retirement plan contributions and the health premium deduction) is when there is material participation, and;

If you provide significant services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business. Significant services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc.

[kaimana]

Sounds like an obvious attempt to avoid SE tax...and if it is obvious attempt, knowledgable attempt, isn't that illegal? anyone agree?

[newbie]

If you provide significant services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business. Significant services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc.

Even if only one cabin I sway toward Schedule C if you're providing more than the norm in the way of service such as furnishing of furniture, beds, dishes, linens with cabins cleaned and bedding changed before and after guests(or at least I would hope) all for the convenience of the guests, short term guests as opposed to tenants.

Would agree that the living trust only offers a potential savings by avoiding probate.

[BHoffman]

I've changed my mind. I'm voting for Sch E based on the following:

dsi says the taxpayer does not provide services. He hires a management company who takes care of all the daily work.

IRC 469(c)(2)

All rental activites are passive, even if the taxpayer materially participates, unless he or she is a real estate professional.

See also IRC 469(c)(7) for information regarding whether the activity rises to the level of a business. See a snip below:

"(7) Special rules for taxpayers in real property business

(B) Taxpayers to whom paragraph applies
This paragraph shall apply to a taxpayer for a taxable year
if -
(i) more than one-half of the personal services performed
in trades or businesses by the taxpayer during such taxable
year are performed in real property trades or businesses in
which the taxpayer materially participates, and
(ii) such taxpayer performs more than 750 hours of services
during the taxable year in real property trades or businesses
in which the taxpayer materially participates.

So, does the client satisfy (i) and (ii)? If so, then it looks like Sch C. If not, then I think Sch E.

Hope this helps.

[dsi]

My client does have a maid who changes the linen, does the laundry, and the cleaning of each of the cabins...not apartments...cabins. He even does some of the repairs himself.