LLC - Capitalize

[S T]

Have Several Questions on this one - As it appears I need to file Form 1065 for periods 2008 through 2009, and then as well report 2010 partial year with Lease Income, and 2011 with Lease Income.

I believe I need to Capitalize all Interest and Property Taxes - ?? Insurance and Mileage??

Have a client that purchased property to build in April 2007 - joint venture so to speak. ( 2 people) Commercial Building/ Artist Studios - Large Bldg divided into Studios for Artists to lease-- Started construction in 2007 with a course of construction loan - No tax reporting and none filed

Set up LLC in 2008 - Bldg still not completed and this goes through all of 2009 and up to approx August 2010 - when first lease is present. No Tax Reporting filed

Question, 2007 - nothing to report - just track all expenses and capitalize including property tax, insurance and interest paid?? Track the partners accounts for $$ paid in

Question 2008 - Filed for EIN# as LLC - partnership - Most all of the expenses Should be capitalized, including interest, insurance and property taxes? Small amount in some opertaing expenses - No Leasing/Rental Activity ??? All would be Capitalized?

Question 2009, Most all of the expenses should be capitalized, including interest, insurance and property taxes - No Leasing/Rental Activity ??? Another Year Added to Capitalized Amount?

Question 2010 - Expenses up to first "signed lease" in August 2010 should be capitalized, including Interest, Insurance and Property Taxes - ?? Then actual expenses, including interest, property tax and insurance can be expensed?? Finally, First part of year is Capitalized, then Start Depreciation and report Income and expenses on Lease Date and subsequent leases in 2010? Not sure how to pro-rate Lease spaces except sq ftg, lease income?

There is a EIN on file, NO returns prepared for any period

As far as we know, there are no notices received from IRS - but then we have been reconstructing records for weeks going back to 2007 - so the notices might be lost or MIA

Mileage at Standard Mileage Rate - is it an operating expense or Capitalized from 2007 - August 2010 ?? Meeting Contractors, Hiring Laborers, Picking Up Construction Supplies, etc.

Thanks

Sandy

[Gary2]

Are they functioning as general contractors? Or just hiring a GC and others?

My first thought on a rental property is whether a partnership return is even required. As I'm sure you know, mere co-ownership of a Schedule E rental with proportional income and expense sharing doesn't create a partnership. But even ignoring the LLC issue, I'm not sure whether the fact that they're constructing the building changes that.

As for the LLC, we know that LLC ownership for a Schedule C activity disqualifies a husband and wife from the QJV rules. But I'm not sure whether co-ownership of an LLC whose sole activity is Schedule E rental does the same. Even if it does, can it meet the requirements for opting out of the Subchapter K partnership rules?

Of course, this doesn't address your underlying questions, which are independent of whether or not it's reported as partnership income. I don't understand the issue about pro-rating the lease spaces. Are you saying that only some of them were available for rent at first? Or were they all available at more or less the same time, but only some were actually rented? If the latter, then wouldn't the date of availability be the only one that matters?

[Gretel]

Here are my 2 cents from my experience with the same issue.

As Gary said as long as they are not an LLC they have the choice of filing 2 schedule E's, which does not even apply since the only deductible expense would be the RE taxes and they go on schedule A. It's the taxpayers choice to deduct or to capitalize.

In my opinion an LLC is required to file form 1065, however I am not very familiar with electing out of subchapter K treatment and if this in any option.

With my multi-rentals, I have capitalized all expenses including the RE taxes. Upon availability I started to prorate interest expenses as rental expenses according to how many units were available at what time. Signing the lease doesn't have any bearing on when expenses become rental expenses. Insurance should also be a cut and dried issues, since construction insurance is a different type then insurance needed for leasing. As said before taxes is a choice and certainly should be deducted as rental expenses as soon as possible.

I didn't have the mileage issue. If the members were reimbursed (SMR or actual - their choice) then these expenses will also be capitalized. However, the operating agreement needs to state what qualifies for reimbursement. If they were not reimbursed they generally can deduct on Schedule E 2nd page but only if operating agreement states that they are required to pay expenses on their own and what expenses. Then you have the issue that these expenses should actually be capitalized and I do not have any answer to this.

You can call me or e-mail me if you like.

[JG EA]

The LLC complicates it in my mind. But in general co- ownership does not mean a partnership return. See Reg. 301.7701-1(a)(2).

[Gretel]

The LLC complicates it in my mind. But in general co- ownership does not mean a partnership return. See Reg. 301.7701-1(a)(2).

Well, "General" is of no value if the entity is in fact a LLC. Page 1 of the instructions for Form 8832 clearly states the "Default Rule" if no election is made, which is - A partnership if it has two or more members - Disregarded as an entity separate from its owner if it has a single owner.

[S T]

I don't understand the issue about pro-rating the lease spaces. Are you saying that only some of them were available for rent at first? Or were they all available at more or less the same time, but only some were actually rented? If the latter, then wouldn't the date of availability be the only one that matters?

Maybe not an issue, as the Renovation was taking place, they were trying to lease "spaces" as quickly as they could. So not every space was available as of August 2010 - it was like finish one space, lease, go to next space- complete and then , lease, etc.

Still through May 2012, there are 4 vacancies, however, the "spaces" are completed and available.

Here are my 2 cents from my experience with the same issue.

As Gary said as long as they are not an LLC they have the choice of filing 2 schedule E's, which does not even apply since the only deductible expense would be the RE taxes and they go on schedule A. It's the taxpayers choice to deduct or to capitalize.

Just received the paperwork, LLC was formed May 2007 - real estate purchased for renovation and conversion to Artist Studios for Lease - EIN request form SS-4 was filed October 2008 and was indicated as a partnership.

In my opinion an LLC is required to file form 1065, however I am not very familiar with electing out of subchapter K treatment and if this in any option.

As this is rental property would not it be a Form 1065, with form 8825 rental real estate income?

With my multi-rentals, I have capitalized all expenses including the RE taxes. Upon availability I started to prorate interest expenses as rental expenses according to how many units were available at what time

As the renovations took so long, and the first studio was leased in August 2010 - I am thinking to use that date for Active Rental - Capitalize all expenses prior to that date.

I didn't have the mileage issue. If the members were reimbursed (SMR or actual - their choice) then these expenses will also be capitalized. However, the operating agreement needs to state what qualifies for reimbursement.

Operating Agreement does State Reimbursement of Expenses - I will capitalize the mileage based on SMR

Thanks for the insight and direction - Now I have to get to work and start filing Tax Returns back to 2007

Sandy

[Gretel]

As this is rental property would not it be a Form 1065, with form 8825 rental real estate income?

Yes, it would.

Operating Agreement does State Reimbursement of Expenses - I will capitalize the mileage based on SMR

I am still wondering if they actually got paid the mileage? Somehow the way you word this sounds like maybe not?

Anyway, good luck.

[S T]

Your question is valid - No the one Member that was in charge of the renovations, has not been reimbursed by the LLC - there are NO $$ in the LLC - just been a Money Pit- Just now in 2011-2012 starting to break even with the Lease Income vs the Loan payments, insurance, property taxes etc.

Can it be shown as a "Loan" to LLC or "reimbursement" not paid, and still capitalized?

Another question - years from 2007 - 2010 when the property was not placed in service as a rental, but there are some small minor operating expenses - is that shown on just the 1065 and not using the 8825 form? Reason I ask is I have a "draft" copy from the prior accountant and that is what he prepared - No depreciation, no mortgage interest, etc that needs to be capitalized

Now I have found out that there are actually 3 members in the LLC, 2 members are H/W each 25%, and then 3rd Member at 50% - so should there not be a separate K-1 for each of the 3 members, that is not how the prior accountant prepared the "draft" - Has H/W as 50% under one K-1 form - State is Texas - Again this is a "draft" form that I am referring to - it was not filed.

Thanks

Sandy

[Gretel]

Your question is valid - No the one Member that was in charge of the renovations, has not been reimbursed by the LLC - there are NO $$ in the LLC - just been a Money Pit- Just now in 2011-2012 starting to break even with the Lease Income vs the Loan payments, insurance, property taxes etc.

Can it be shown as a "Loan" to LLC or "reimbursement" not paid, and still capitalized?

Did they ever put any money as their capital in the LLC? Just making a book entry after the fact to cover up a non-paid reimbursement brings your client into dangerous waters, as does never paying in any capital. I am not saying that this is wrong. I definitely would make client(s) either their capital contributions or have them loan money to LLC and pay the reimbursements.

This has a lot to do with liability protection similar as with a Corporation. Yes, the LLC does not require all that burdensome paperwork but if the members act as though it doesn't exist, so would any lawyer if someone wanted to sue the members personally.

Another question - years from 2007 - 2010 when the property was not placed in service as a rental, but there are some small minor operating expenses - is that shown on just the 1065 and not using the 8825 form? Reason I ask is I have a "draft" copy from the prior accountant and that is what he prepared - No depreciation, no mortgage interest, etc that needs to be capitalized

Well, I think technically any expenses not related to the rental itself would go on the 1065. F.e. In my state their is a fee of $15 for SOS every year, but if this is all there is it doesn't really matter where it shows.

Now I have found out that there are actually 3 members in the LLC, 2 members are H/W each 25%, and then 3rd Member at 50% - so should there not be a separate K-1 for each of the 3 members, that is not how the prior accountant prepared the "draft" - Has H/W as 50% under one K-1 form - State is Texas - Again this is a "draft" form that I am referring to - it was not filed.

Maybe you haven't seen all the documents yet? Maybe they changed Operating Agreement at some point? Yes, each member needs to get their own K-1.

[JG EA]

Well, "General" is of no value if the entity is in fact a LLC. Page 1 of the instructions for Form 8832 clearly states the "Default Rule" if no election is made, which is - A partnership if it has two or more members - Disregarded as an entity separate from its owner if it has a single owner.

My goal was not to post something of "no value". There have been lots of discussions about this and I thought the Reg reference may be beneficial in some cases if not this one.

[Gary2]

Well, "General" is of no value if the entity is in fact a LLC. Page 1 of the instructions for Form 8832 clearly states the "Default Rule" if no election is made, which is - A partnership if it has two or more members - Disregarded as an entity separate from its owner if it has a single owner.

Form 8832 only applies to business entities. It's still not clear to me whether an LLC whose sole activity is rental real estate is, in fact, a business entity. I don't know the answer, and it's possible that there is neither guidance nor case law on it.

I'll even go as far as saying that when the subject came up for myself and other family members, I refused to participate in a multi-member LLC for that purpose, because of the risk that your conclusion is correct. (We wound up going with multiple SMLLCs as co-owners.) However, I don't believe the wording on the 8832 is adequate to prove such a conclusion, because we know that mere co-ownership isn't a partnership but nothing about the 8832 confirms that.

[Gretel]

Form 8832 only applies to business entities. It's still not clear to me whether an LLC whose sole activity is rental real estate is, in fact, a business entity. I don't know the answer, and it's possible that there is neither guidance nor case law on it.

There is recent guidance on this and it drives me nuts that I can't find it. Beanna Whitlock talked about this. I will look again and maybe I have to contact her. I believe the IRS made it clear that they view any LLC as a business no matter if it is real estate or something else.

OK, how about the "Passive Activity Loss Audit Technique Guide"? Look at page 6-10. It also says that LLC's need to file form 1065.

[S T]

Thanks Gretel for responding on this thread.

Did they ever put any money as their capital in the LLC? Just making a book entry after the fact to cover up a non-paid reimbursement brings your client into dangerous waters, as does never paying in any capital. I am not saying that this is wrong. I definitely would make client(s) either their capital contributions or have them loan money to LLC and pay the reimbursements

Yes we have the "original" Capital recorded, and that is also recorded in the Operating Agreement - and we have accounted in the Books for everything that can be susbstantiated for all expenses of Members and have all of the associated Accounts Dcouments.

This is one of those Projects that just exceeded the Original Estimates for completion and fruition (sp)

We are left with this last little "hiccup" on how to treat the one Managing Members Mileage - I say either "ignore" or "capitalize" Not sure which is the proper method. Would be the mileage from 2007 - Sept 2010 for the Renvovation Period prior to Active Rental.

Finally now leases and income late 2010 -2011, and they are applying for a "New Loan" thereby some of my accounting questions.

My thought is not necessarily for tax purposes, so capitalizing as much as should be up to about August 2010 - not much tax benefit on all of the past returns due - and then move forward for the later of 2010 and 2011 - which still operating at a loss, when it actually become a "viable" rental.

Thanks to all participating in this thread,

Sandy