Retirement Plan - Real Estate Professional

[KC-CPA]

I have a client who has W-2 income over $600k. His wife and him also have a rental partnership (about 8 rentals) business that she runs. Overall the rental business lost $30k last year and will most likely continue to have a loss in future years. Previous accountant set them up as active since she spends most of her time running/managing the rentals. The partnership is set up that she owns 80% and he owns 20%, income/loss for partnership flows to their 1040 on schedule E as non-passive income.

Here is the question: They want to set up a retirement account for her through their business and what is the best way to do that? I have not had this scenario and so I am looking for recommendations and ideas. The fact that the rental partnership has no income seems to be a problem to me, but is there a way around this.

Thanks.

[Roland Slugg]

A retirement plan can be established for a "trade or business." Managing one's own rental property is neither a trade nor a business.

Are you sure the losses can be treated as nonpassive? Does the W really meet the requirements to be regarded as a real estate professional?

Also, the "partnership" you described probably isn't really a partnership at all for federal tax reporting purposes, and should not be filing F-1065. See the definition of a partnership ... and what is not one ... in the instructions for F-1065, on page 2 or 3, I believe.

[Snaggletooth]

Salary available

Don't know all the details of the tax planning which created this situation, but I would suggest they be revisited.

As you may know, with such a huge income, there is no advantage to "active" participation for purposes of deducting these losses as such losses phase out at $150K. If there is any advantage at all, it would be for claiming sufficient income to allow self-employment for purposes of the retirement plan. But for the reasons Roland describes above, I don't know how rental income can qualify, and not only that but a rental loss. I do not think a partnership treatment is correct either, but even if they choose to file a partnership return, the character of the income passes through as rent and not partnership operational income.

However, with $600,000 in income, surely there could be some justification for paying a salary. A W-2 salary could be deducted, even from rent, and create enough earned income to fund a retirement plan. I can imagine no one wants to pay any kind of payroll tax (or SE tax) on wages but I believe the choice boils down to this.

[Burke]

Looks like all she could qualify for is a spousal IRA, with a max contribution of $6,500 if she is over 50, and if she has no wage income herself. Or does she already have that?

[Roland Slugg]

Thinking it through

Neither of the two above replies is likely to work. Let's take them one at a time:

A W-2 salary could be deducted, even from rent, and create enough earned income to fund a retirement plan.

O'contraire. If a partner is paid a salary, it is a "guaranteed payment" to that partner and reported on Schedule K-1, not on a W-2. Partners of partnerships (like sole proprietors) don't get a W-2 from their partnership. So let's say this real estate "partnership" (if it even is a partnership for tax purposes) pays W a salary/guaranteed payment of, say, $100,000 for managing the rentals. That salary would increase the p'ship's loss from $30,000 to $130,000. W's share of the p'ship income or loss is 80%, so now the loss that flows through to her is $104,000 (80% of $130,000). Combine that loss with her guaranteed payment of $100,000, and she has an overall net loss of $4,000. H's share of the loss is $26,000 (20% of $130,000), so H&W's combined loss is the same $30,000 they started with. The above scheme would accomplish nothing.

Regarding Snag's comment about the rental loss not being deductible if the T/P's AGI exceeds $150,000. That is true unless W qualifies as a "real estate professional" as defined in Code §469(c)(7)(B)(i) and (ii). If she does, the loss would be allowed despite the usual $150,000 limitation. In my original reply above, however, I questioned her ability to so qualify.

Looks like all she could qualify for is a spousal IRA, with a max contribution of $6,500 if she is over 50.

Only if the woman's H, who makes $600k, is NOT covered by a retirement plan at work. Do you think that's very likely? And if he is covered, she doesn't qualify for an IRA deduction.

... and if she has no wage income herself.

Even if she does have wage income herself she won't qualify for a deductible IRA, unless neither she nor her H is covered by a retirement plan at work. Her own separate income is irrelevant. The IRA deduction depends on a H&W's combined earned income and the two phase-out levels, and based on the income levels stated in the OP, this couple makes way too much for either of them to qualify for a deductible IRA.

[DaveinTexas]

ND Trad to Roth

Looks like if the partnership will "continue to have a loss" that the wife's only hope is a spousal IRA. She could contribute to a Traditional IRA and deem it Non-Deductible. This will offer no tax benefit but if she has no other IRA other than the one she will open (check to see if she has rolled over any old 401Ks to an IRA), she could consider converting the ND IRA contribution to a Roth IRA each year (back door Roth contribution).

I know the substance doctrine has been codified, step doctrine, etc. It's worth a shot if the IRS has not specifically outlawed the transaction and I assume the husband is covered by a retirement plan at work.

Hey Roland, would this scenario play out?
1. Rental Partnership pays an entity (owned solely by wife) a management fee to manage rental properties, arrange and approve repairs/maintenance, evict renters, collects rent and pays it over to the partnership.
2. Said entity is an LLC taxed as S Corp or just a plain ol' S Corp.
3. Wife draws a salary out of S Corp.
4. Wife sets up a SEP IRA and S Corp contributes up to 25% of salary.
5. I do realize the management fee would have to be a high percentage to make this feasible; but what would someone pay to manage 8 properties on a daily basis?

I know Payroll Taxes will be paid BUT if the true intent is to build a retirement savings, this accomplishes the feat in two ways; 1) Builds wife's SS earnings and 2) Funds a SEP IRA for the wife.

Just a thought.

[KC-CPA]

Re-evaluating Rental Retirement

Out of all the comments, the most interesting one is the setting up an S-Corp as a property management company for the rental business, but that does not seem clear cut either, as the income of the rental properties would most likely be equal to the salary of the W, so the income of the S corp would be small therefore the SEP would be limited on contribution, correct?

I think the bottom line is, the client is trying to stretch and is too focused on the retirement and not able to see or understand all the other angles. By the way, the original appointment to discuss this in August was canceled, but now the request is to discuss next week to solve the world before year-end.

I am really not interested in jumping through hoops to accomplish this if its not a solid strategy.

Thank you guys for all your replies and thoughts! If you have more to contribute let me know.