Real property in an LLC

[kathyc2]

Husband/wife held 2 properties in an LLC. Both were sold in 2016 at a loss. One was an outright sale and the other on a land contract. Their attorney prefers to keep the LLC open until the land contract is paid off (10 years). Their 2016 income before the loss is close to the 150K mark. Am I correct that as long as the LLC is still active, their deductible loss on it is limited as passive, but if we close the LLC they can claim the entire loss in the year of closure?

[Snaggletooth]

Loss has occurred

Kathy help me with this as I ramble, and correct the facts if necessary.

"Passive" treatment is totally consummated if property is sold. As in "over", "past tense", "gone" or any other idiom, right? Losses suspended by passive activity rules are disgorged with the sale, and whatever basis has been accumulated has now become a legitimate deductible loss at the point of sale in 2016.

There is the option of installment sale election, but I've never heard of it being used to drag out a loss. I believe the loss occurs in 2016 in its totality.

If the advice is taken to keep the LLC open for the duration of the payment, I believe the only relevant item from this discussion would be the interest income. If the LLC is operating as a C corp, there may be a danger of personal service corporation, although I can't imagine application of a PSC for a small amount as this. With no other activity going on, if this is going to drag on for 10 years, I might consider converting to an S corp to avoid double taxation.

If you convert, you may sequester the current earnings from dividend treatment until invaded upon dissolution.

[kathyc2]

Sorry, I didn't say that the LLC is taxed as a partnership. All that remains on the company books at the end of 2016 is a little cash, land contract receivable and off-setting equity. It's not a 6252 transaction.

This is a new one for me, but I'm finding that if it was on a Sch E, then the sale of buildings would be a capital loss subject to the 3K annual max.

However, since it's an 1065 LLC the loss on sale is subject to passive loss rules until such time as the LLC closes. After that time the loss is fully deductible and not subject to 3K capital loss.

Am I missing something?

[Snaggletooth]

Don't think so

Kathy, I'm usually not as knowledgeable as you, but I don't know why a loss can't be fully reported in 2016 and subject to the $3,000 cap for each "partner." The $3000 cap applies to the individual returns and does not limit the loss reported on the K-1. The loss was incurred by the LLC, and I don't know why taking the loss has to be postponed until the LLC closes. Is there a cite for this? I don't how there could be since the IRS does not even recognize an LLC.

The LLC survives as a partnership, reporting only interest for 10 years.

Based on my knowledge and experience, this is how I would treat it. But I've been wrong before. Maybe others will post.

[kathyc2]

Kathy, I'm usually not as knowledgeable as you, .

Haha! This is what I'm getting as I input it in the software. I was hoping that someone who had this situation before could verify that software is handling it correctly and save me some research time... Looking for an easy way to eliminate some of the backlog piles on my desk.

[ttbtaxes]

I see no reason why the losses do not flow through in the year of sale. Take a look at the May 2008 edition of the Tax Advisor and read the article. Disposing of an Activity to Release Suspended Passive Losses.

[Burke]

The sale of rental real estate is a 4797 fully deductible loss and not subject to the $3K cap. IMO, the fact that it was in an LLC (not taxed as a corporation) does not alter this fact. So the only thing that is now coming in is interest on the sale and would be reported each year on Sche B on their joint return. Why would he feel the LLC must be kept open? Do they intend to purchase more rental property in the future?

[kathyc2]

The attorney wants to keep the LLC open as the land contract is between the LLC and the buyer. The loss was around 40K so taking it all this year or next rather than in dribs and drabs makes a big difference.

I'm finding 469g which seems to support Pro's handling of it:

(g) Dispositions of entire interest in passive activity If during the taxable year a taxpayer disposes of his entire interest in any passive activity (or former passive activity), the following rules shall apply:
(1) Fully taxable transaction
(A) In general If all gain or loss realized on such disposition is recognized, the excess of—
(i) any loss from such activity for such taxable year (determined after the application of subsection (b)), over

(ii) any net income or gain for such taxable year from all other passive activities (determined after the application of subsection (b)),

shall be treated as a loss which is not from a passive activity.

[TaxGuyBill]

You use ProSeries, right?

On the Form 8825 worksheet, under Question #1, did you check the box saying the property was completely disposed? I think that should do it and the loss will flow to the K-1s.

On the Schedule E worksheet (for Form 1040), the comparable thing is box "H", and that is what releases all of the passive losses. I think that box I mentioned above for the 1065 is the equivalent of box "H".

[Burke]

I am a little confused. Exactly how is ProSeries handling it? Not as a fully deductible loss? Maybe there is unrecaptured 1250 gain involved?

[kathyc2]

You use ProSeries, right?

On the Form 8825 worksheet, under Question #1, did you check the box saying the property was completely disposed? I think that should do it and the loss will flow to the K-1s.

On the Schedule E worksheet (for Form 1040), the comparable thing is box "H", and that is what releases all of the passive losses. I think that box I mentioned above for the 1065 is the equivalent of box "H".

The loss is properly flowing to K-1's box 10 as 1231 loss. When I enter the K-1's on the 1040, Pro is limiting the loss to passive rules. If on the 1040 K1 worksheet I check that's the partnership interest was disposed of, the full loss is reflected. My reading of 469g is that is how it is supposed to be reported, that as long as they have still have partnership interest, the loss is deferred subject to passive loss rules.

[TaxGuyBill]

The loss is properly flowing to K-1's box 10 as 1231 loss. When I enter the K-1's on the 1040, Pro is limiting the loss to passive rules. If on the 1040 K1 worksheet I check that's the partnership interest was disposed of, the full loss is reflected. My reading of 469g is that is how it is supposed to be reported, that as long as they have still have partnership interest, the loss is deferred subject to passive loss rules.

Okay, yes, I think you are right. My mind was on something else.

As a side note, if the taxpayer's income was under $150,000 and he was "active", you can check that box under Line 2 to utilize up to $25,000 of that loss.

[taxea]

This mess is the result of seeking the advice of the wrong attorney. TP should have consulted a business attorney and a tax attorney. A couple "LLC" doesn't require a 1065.

[ttbtaxes]

This mess is the result of seeking the advice of the wrong attorney. TP should have consulted a business attorney and a tax attorney. A couple "LLC" doesn't require a 1065.

I beg to differ. A husband and wife rental LLC does require a partnership tax return unless in a community-property state.

A trade or business owned by a husband and wife can elect under Section 761(f)(2) to be treated as a qualified joint venture (QJV) and file two Schedule Cs rather than a partnership return. That option is not available when they are the two members of an LLC.

[Burke]

The loss is properly flowing to K-1's box 10 as 1231 loss. When I enter the K-1's on the 1040, Pro is limiting the loss to passive rules. If on the 1040 K1 worksheet I check that's the partnership interest was disposed of, the full loss is reflected. My reading of 469g is that is how it is supposed to be reported, that as long as they have still have partnership interest, the loss is deferred subject to passive loss rules.

That's not how I was reading the IRC 469 which you posted. Note the last lines under (A) "if all gain or loss realized upon disposition is recognized,...the excess of any loss...over any
income or gain...from all other passive activities, shall be treated as a loss which is not from a passive activity." So were there other passive activities involved with any gains? Do you have a 6252 form in the return which may be causing this to happen?