1065 Required for LLC?

[PDAllen]

Two brothers formed an LLC, bought a house as a residential rental property, and titled it to the LLC. That's the only property the LLC owns and the LLC is not engaged in any other business activities.

I think this requires a 1065 to be filed, even though it is just co-owning rental real estate. Is it written somewhere other than pub 541 that a multi-member LLC is required to file a 1065? Something more definitive?

Thanks!

[DaveinTexas]

Start Here

I'll give my opinion and then you can look through the stuff I have posted below for more assistance with this question. The fact that the brothers formed the LLC AND they are not Husband/Wife in a Community Property State sort of sealed the fate for the filing of this return (Partnership unless they elect to be taxed as a Corp). The concept of the mere co-ownership of a property doesn't conceptually create a Partnership is reserved for business activities that do not involve an LLC. Now, on to the gobbledygook!

See 26 CFR 301.7701-3(f)(2) - Classification of certain business entities. See this link to the cite: https://www.law.cornell.edu/cfr/text/26/301.7701-3

Here is the verbiage from the cite:
(2) Partnerships and single member entities. An eligible entity classified as a partnership becomes disregarded as an entity separate from its owner when the entity's membership is reduced to one member. A single member entity disregarded as an entity separate from its owner is classified as a partnership when the entity has more than one member. If an elective classification change under paragraph (c) of this section is effective at the same time as a membership change described in this paragraph (f)(2), the deemed transactions in paragraph (g) of this section resulting from the elective change preempt the transactions that would result from the change in membership.

And more from the "Check the Box" Regulations:
CLASSIFICATION RULES
An eligible entity with at least two members can elect to be classified as a partnership or as a corporation for federal tax purposes. An eligible entity with a single owner can elect to be classified as a corporation or can be disregarded as an entity separate from its owner under regulations section 301.7701-3(a). If the entity is disregarded, it is treated as a sole proprietorship if it is owned by an individual; if it is owned by a corporation, it is treated as a branch or division.

Under default rules, unless the entity elects otherwise, a domestic eligible entity is classified as a partnership if it has at least two members; if it has a single owner, it is disregarded. Accordingly, a domestic general partnership, a limited partnership or a limited liability company (LLC) is classified as a partnership for federal tax purposes if an election is not filed. A foreign entity is classified as a corporation if all members have limited liability. If it has a single owner, it is disregarded if the owner does not have limited liability (regulations section 301.7701-3[b]).

An eligible entity that wants to elect out of its default classification or change its classification can do so by filing Form 8832, Entity Classification Election. If an eligible entity makes an election to change its classification (other than an existing entitys election to change its classification as of January 1, 1997), under regulations section 301.7701-3(c) the entity cannot change its classification again for five years. This limit applies only to changes by election. Accordingly, a new eligible entity that elects out of its default classification may change its classification by election at any time. In addition, an entity generally may change its classification if the entity's business is transferred to another entity.

[Roland Slugg]

The IRS wants income reported on people's returns correctly. I don't believe the non-filing of a p'ship return would bother them in the slightest. If these were my clients, I would advise them to report their pro-rata shares of everything on Schedule E of their own returns.

Or you can read all that gobbledygook and try to figure out what it says.

[taxea]

I agree with Roland. Usually the reason for the LLC is focused on liability. However, having said that, make sure that they have a detailed written agreement that addresses all terms of the relationship.

[DaveinTexas]

I disagree, respectfully

I would, at the very least, tell the client to consider filing an initial and final 1065. I think the rules are clear (to me) that if you have greater than 1 Member in an LLC, the default tax classification is a Partnership. The EIN obtained has no legal bearing on the classification but the fact that this LLC has 2 or more members means you cannot treat this LLC, for tax purposes, as 2 DREs reporting income on 2 Schedule Es UNLESS the LLC is solely owned by Husband and Wife in a Community Property State.

To avoid confusion your client should consider dissolving the LLC and operate the rental property as a joint venture; 2 Schedule Es. The LLC complicates matters in my opinion.

The gobbledygook is a good read, in my opinion (which may be worth less than 2 cents due to inflation).

Also consider Rev Proc 2002-69 (more gobbledygook that everyone on this board should read); here is a section of the verbiage that will be helpful in this situation:

SECTION 4. APPLICATION
.01 If a qualified entity (as described in section 3.02 of this revenue procedure), and the husband and wife as community property owners, treat the entity as a disregarded entity for federal tax purposes, the Internal Revenue Service will accept the position
that the entity is a disregarded entity for federal tax purposes. .02 If a qualified entity (as described in section 3.02 of this revenue procedure), and the husband and wife as community property owners, treat the entity as a partnership for federal tax purposes and file the appropriate partnership returns, the Internal Revenue Service will accept the position that the entity is a partnership for federal tax purposes. .03 A change in reporting position will be treated for federal tax purposes as a conversion
of the entity.

Again, it seems clear to me that the IRS will only accept the DRE treatment IF the only Members are H&W in a CP State. I would love to see other guidance that would support a different position.

[kathyc2]

IMO if you circumvent the rules of an LLC you also potentially lose the liability protection.

[DaveinTexas]

Great Point!

Why would anyone want to cause any "confusion" in an entity that is designed to shield the liability of the owners? What if the LLC is sued and lo' and behold, the Operating Agreement and the IRS state the entity will be classified as a Partnership and we find that the "partners" never filed a Partnership return? Creditors don't like confusion; attorneys do because then they have an opportunity to circumvent (I stole Kathy's word) the LLC so they can attach judgement to the Members.

If the client doesn't want to file a Partnership return, I would advise them to dissolve the LLC and obtain their own umbrella policies in addition to homeowner's insurance (they probably already have HI).

[taxea]

okay so what was the purpose of the LLC? The IRS confuses the matter because they don't consider a rental a business. If you don't have a business how do you have a business partnership?

[DaveinTexas]

Missed the Mark

The point of the conversation is not the underlying activity (rental activity; passive income, not considered a trade or business) it is the fact that the rental activity is carried on within an LLC with 2 or more members that are not H&W.

The LLC cannot, statutorily, legally, common sensically be classified, for tax purposes, 2 or 1 disregarded entities (or a Joint Venture). The Members can't just report their income on 2 Schedule Es UNLESS they dissolve the LLC.

Option 1) Dissolve the LLC, problem solved and the income can be split on the 2 "partner's" respective Schedule Es. (Talk to the Attorney First)

Option 2) Operate the rental activity within the LLC and file a Partnership Return. (Not a Bad Idea)

Option 3) Give me the building and the LLC and I will report the income and expenses on my Schedule E (Not Likely)

[spanel]

The point of the conversation is not the underlying activity (rental activity; passive income, not considered a trade or business) it is the fact that the rental activity is carried on within an LLC with 2 or more members that are not H&W.

The LLC cannot, statutorily, legally, common sensically be classified, for tax purposes, 2 or 1 disregarded entities (or a Joint Venture). The Members can't just report their income on 2 Schedule Es UNLESS they dissolve the LLC.

Option 1) Dissolve the LLC, problem solved and the income can be split on the 2 "partner's" respective Schedule Es. (Talk to the Attorney First)

Option 2) Operate the rental activity within the LLC and file a Partnership Return. (Not a Bad Idea)

Option 3) Give me the building and the LLC and I will report the income and expenses on my Schedule E (Not Likely)

Whats so bad filing a 1065?

Chris

[DaveinTexas]

Ghosts and Goblins

1065s are scary?

I think the question driving this one home is, is a 1065 required in this case and I say, yes, unless they dissolve that LLC.

[taxea]

I say disolve it and get insurance that will cover their liability concerns.

[spanel]

1065s are scary?

I think the question driving this one home is, is a 1065 required in this case and I say, yes, unless they dissolve that LLC.

My opinion is the 1065 is required regardless of the LLC. (LLC has nothing to do with taxes). This is not a husband/wife owned business and as such needs to be filed on a 1065.

The only was otherwise would be to have 1 owner of the business and pay the other. Splitting the income on a schedule C/E is not the way to do it.

Chris

[Roberts]

the IRS is wanting a return

When you get Tax ID number, the IRS wants a return. If you fail to file a 1065, you'll eventually get a letter asking why you didn't.

The voluntary reporting on individual Schedule Es opens up the other member to potential problems. What if the other member fails to report the income and expenses on their personal return like they claimed? what if they report different numbers? The other member will never know yet the IRS will eventually come calling. If you are reporting a profit and the other member isn't paying their taxes or they gave bad information to the IRS - The IRS may very easily come to you for the money / clarification. The IRS may agree you aren't liable but it'll be after a lot of stress, phone calls and letters.

[DaveinTexas]

Then you have this

My opinion is the 1065 is required regardless of the LLC. (LLC has nothing to do with taxes). This is not a husband/wife owned business and as such needs to be filed on a 1065.

The only was otherwise would be to have 1 owner of the business and pay the other. Splitting the income on a schedule C/E is not the way to do it.

Chris

From IRS:
"A joint undertaking merely to share expenses is not a partnership. Mere co-ownership of property that is maintained and leased or rented is not a partnership. However, if the co-owners provide services to the tenants, a partnership exists."

I agree that filing a 1065 would cut out a LOT of confusion, especially the issues brought up by Roberts.