Real estate investor with a twist

[joanmcq]

Have a new client with three rentals, a commercial building, a triplex and a single family residence. He also has a S-corp which was formed for a different business (now winding down), but now he using it as a construction business to renovate the rentals. He is recording income in the S-corp for the amount of materials and other expenses for capital improvements, and the net is zero. However he is claiming RE pro on his 1040. He is not taking a salary from the S-corp, in fact it is running as a loss, mostly due to the original business running at a loss. So essentially he is trying to sheild himself from construction liabilities by running the work though the corp.

Is RE pro really available if he is not doing the work, but the corp is? He IS the corp.

[BHoffman]

Hi Joan - not sure I understand your concern and giving you a bump. Is it the officer salary (lack thereof) that is the problem?

Hope your tax season is going well and nice to see you on the board.

[Lion]

No

He is NOT the corp.

Please clarify your question. Is it about the S-corp reporting? Salary? Loss? Or, is it about his Form 1040 rentals?

[Burke]

He is recording income in the S-corp for the amount of materials and other expenses for capital improvements, and the net is zero. .

What income exactly is he recording in the S-Corp? Not sure I understand this statement.

[joanmcq]

He is now running three different activities through the S-corp. One is the original business, which is winding down. The second is 'property management' of his rentals: essentially he runs the income and expenses through the S-corp (liability he thinks, looks better to have the checks written to XXXX, Inc.?) which net to zero, and the rentals are reported on his personal Sch E. I haven't asked whether the corp issues him a personal 1099 for rents yet. I do have the QB files, and have tied out the numbers on both returns to each other and the QB files.

The last one is a construction company, which solely works on the renovation of the buildings, in particular the conversion of the commercial space to 'loft' space. Again, he records income in the corp net to the expenses, with a net of zero. The construction is capitalized to the rental. He wants to do the construction through the corp for liability issues, both for current work, and to protect his personal assets from any future claims of construction defects, etc. He does have enough assets where this is a credible concern.

He is not taking a salary from the corp, but he is doing much of the work. It is running at a loss.

But he is claiming RE pro on his personal return. For 2010, it really didn't make any difference; his AGI would have allowed the less than 25k of RE losses anyways.

However, since his corp is in the RE trades, (although also, most of his income is from RE and investments & 3rd party sick pay).

This is a new client, and I've been analyzing his returns for a few weeks now. I hope you can see the difference between my late night original post and the 'after a good night's sleep' and many cups of coffee post I'm making now!!!

[Gretel]

Part of maybe an answer:

See excerpt from Pub. 925 below. It seems to indicate that it doesn't matter if the business is a personal business or a corporation as long as ownership % is met.

In addition to the two requirements you see below, there is a third one. Unless a grouping election is made the 750 hour requirement needs to be met for each single property. At least this is what I remember.

Real Estate Professional

Generally, rental activities are passive activities even if you materially participated in them. However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities. For this purpose, each interest you have in a rental real estate activity is a separate activity, unless you choose to treat all interests in rental real estate activities as one activity. See the Instructions for Schedule E (Form 1040), Supplemental Income and Loss, for information about making this choice.

If you qualified as a real estate professional for 2011, report income or losses from rental real estate activities in which you materially participated as nonpassive income or losses, and complete line 43 of Schedule E (Form 1040). If you also have an unallowed loss from these activities from an earlier year when you did not qualify, see Treatment of former passive activities under Passive Activities, earlier.

Qualifications. You qualified as a real estate professional for the year if you met both of the following requirements.

More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.

You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.

Do not count personal services you performed as an employee in real property trades or businesses unless you were a 5% owner of your employer. You were a 5% owner if you owned (or are considered to have owned) more than 5% of your employer's outstanding stock, outstanding voting stock, or capital or profits interest.
If you file a joint return, do not count your spouse's personal services to determine whether you met the preceding requirements. However, you can count your spouse's participation in an activity in determining if you materially participated.

[joanmcq]

5% shareholder. Duh to me. Thank you!

[Burke]

And that was a very thorough answer to your original question. I am still a little vague on what income he is actually "running through" his S-corp. The second post says property management of the rentals. So that is a deduction from the Sche E. But what expenses related to this? And on the construction end, "he records income to the corporation net to the expenses, with a net of zero." Is he having the rentals pay the corp for construction and the corp is deducting materials and labor, etc? The only reason I am asking, and you have a better handle on this since you have all the records, is that a caveat may be in order if you think he is handling things in this manner, not so much for the liability issues, but so that he can avoid the rental loss limitations by shifting everything thru the S-corp to take a loss in full.

[joanmcq]

No, he's not shifting income/losses. That's what I originally thought, and why I asked for a lot more backup documentation, and traced income, expenses and verified the construction and property management netted to zero on the corp return.

I had a nice chat with him this morning about the RE pro. The 2010 losses on his 1040 were only about $10k, and he really had no benefit from claiming RE pro.

And yes, the rentals pay the corp for the construction costs, and the corp deducts the expenses. The construction is being capitalized.