putting rental real estate in LLC??

[oceanlovin'ea]

i have a client who is thinking of buying a rental house. He wanted to know if it was better to set up an LLC and put the property in the LLC. This is what I have found (or know) so far.
1. House would still be in his name. Banks won't loan to an LLC.
2. Household income (AGI) is almost $200,000. This will rule out a loss on the rental being allowed due to their income.
3. If they set up an LLC, it has to be determined if it is a passive activity or a non-passive activity. It is passive unless they meet the material participation requirements. That is what confuses me a little. Since they both have full time jobs they would not be able to work in the activity more than 500 hours in a year. another requirement is "the individual's participation in the activity constitutes substantially all of the participation in the activity of all individuals for the year including the participation of individuals who did not own any interest in the activity". Does that mean that if they are the only one who participates in the activity they could spend 25 hours during the year and it would constitute a non-passive activity?
Another requirement is "the individual participated in the activity for more than 100 hours during the tax year, and the individual's participation was at least as much as any other individual for the year".

So which is it????? Do they have to participate 500 hours, 100 hours or any amount as long as it is more than anyone else??????

Thanks for your comments in advance.

Linda, EA

[Roberts]

A bank will lend to you if it's in the LLC. Are you saying banks don't lend to corporations?

I'd put it in the LLC for liability, privacy and security purposes.

[Burke]

I think it's a good idea to put rental property into an LLC, and a separate one for each property owned.

[Gary2]

If they set up an LLC, it has to be determined if it is a passive activity or a non-passive activity. It is passive unless they meet the material participation requirements. That is what confuses me a little. Since they both have full time jobs they would not be able to work in the activity more than 500 hours in a year. another requirement is "the individual's participation in the activity constitutes substantially all of the participation in the activity of all individuals for the year including the participation of individuals who did not own any interest in the activity". Does that mean that if they are the only one who participates in the activity they could spend 25 hours during the year and it would constitute a non-passive activity?
Another requirement is "the individual participated in the activity for more than 100 hours during the tax year, and the individual's participation was at least as much as any other individual for the year".

So which is it????? Do they have to participate 500 hours, 100 hours or any amount as long as it is more than anyone else??????

I don't believe that putting it in an LLC changes the underlying nature, so the material participation rules don't help. They'll have to meet the real estate professional rules, which are more stringent.

[oceanlovin'ea]

not real estate professionals

They are not real estate professionals. She is a pharmacist and he is a deputy sheriff. They started to rent their home when they purchased a new one. They are thinking about investing in another rental property. His dad has always had 2 or 3 rental properties.

Yes a bank will lend to a person who is in an LLC. What I said was that they will not loan TO the LLC. The loan would be in the name of the individual.

Why would material participation rules not apply? Are you suggesting that the losses would be allowed under any circumstances?

Linda, EA

[Gary2]

Why would material participation rules not apply? Are you suggesting that the losses would be allowed under any circumstances?

Material participation never applies to rental real estate (unless the rental itself is non-passive, e.g. a hotel or B&B). Otherwise, everyone with a duplex would qualify under the "substantially all the participation" rule for material participation, at least for the years that don't require hiring people for maintenance. Pub. 925 gets into this. I wouldn't rule out the possibility of some clever way around this, but I don't know of any.

The losses don't disappear; they'll carry forward.

[oceanlovin'ea]

clarification

Ok, just to clarify and make sure that I understand:

It really doesn't matter if it is rental property on Schedule E or in an LLC and it flows through to Schedule E page 2, it will be passive activity.

The losses will have to be carried forward until the property is sold or their income is low enough to allow the losses.

Material participation on K-1's would only apply to businesses and not to rental property.

The advantage to putting the property in the LLC would be liability protection.

Is that correct?

Thanks so much.

Linda, EA

[Gary2]

Will it be a single member LLC? The original post uses both "he/his" and "they", so I'm not sure which. An SMLLC will report on page 1 of Sch. E, not page 2. Otherwise, everything looks ok.

Also, the property needs to be in the LLC's name, otherwise the LLC is pointless. It's ok if he or they co-sign the loan, but they may want to check with an attorney to see if they still get liability protection if the loan is strictly in personal name. Putting rentals into LLCs is common enough that they should be able to find a commercial lender who can work with them on this.

[oceanlovin'ea]

husband and wife

it is a husband and wife. I think they would probably put both names on LLC and on house loan. That would dictate a 1065 and a K-1 that would go on page 2 of schedule E.

Thanks.

Linda, EA