Partner Living in Partnership Property

[kdhill]

Yes. The property is in the LLC's name.

[Dude]

Is the title of the property in the name of the LLC now?

[TaxGuyBill]

It may well be feasible to set it up so the partner-occupant only shares in capital transaction, not profit or loss.

That makes sense. In my opinion, that is what could make this weird situation much more logical.

[Rapid Robert]

Since this will be the initial partnership return, I'd advise them that they still have time to set up a written partnership agreement before the return is filed.

"It was just three brothers that inherited a house from their mother and one brother decided he wanted to live in it."

I completely understand why the other two brothers might want a more formal arrangement (such as a partnership). Not only does it allow for enhanced accounting related to the annual activity tax returns, but it also formalizes what might happen if/when one partner wants to be bought out by the partnership or sells their interest or leaves it to an heir. Or, if/when the partner-occupant moves out, for any number of reasons (you did mention an S.O., didn't you?) Depending on the value of the property, it might well be advised to consult an attorney. Or, if feeling competent, use an online service like LegalZoom or RocketLawyer.

It may well be feasible to set it up so the partner-occupant only shares in capital transaction, not profit or loss. Something more or less tax-neutral for that one. To repeat, paying tax on partnership profits, assuming no distributions of property, increases basis in the partnership, which will come in handy for tax purposes some day down the road.

From a practice management viewpoint, with whom have you engaged? Only the partnership, or the partner-occupant on his individual return, or both? There could be conflict of interest here, so watch for that and give notice or get waivers of same.

[kdhill]

Good point.

[Lion]

They = all three signed off on the BS? Or, only one? Don't risk getting in the middle of a disagreement or all out fight.

[kdhill]

Well, they prepared a P & L and Balance Sheet for me. The equity section of the balance sheet clearly indicates that they're splitting profits & capital three ways.

[Lion]

Who is deciding how to split the profits? Loss? Capital?

[kdhill]

There is no partnership agreement.

[Rapid Robert]

Okay. I see your point taxguy. He's paying FMV to live there so I'll file the 1065 on 100% of income and expense and he'll get to pay tax on his 1/3 of the profit. Thanks for everyone's input on this!

That was the same point I made about no personal use if paying FMR.

Why does the profit have to be split 3 ways evenly? What does the partnership agreement say? If you look at Schedule K-1(1065) you will see that a partner can have different percents of the partnership profit, loss, and capital. Also, paying tax on "profit" now is just a timing difference, right (since he would be increasing his basis in the partnership)? Plus, under this arrangement he gets to deduct his share of depreciation, insurance, repairs, QBI, etc, that a regular homeowner does not get to deduct.

[kdhill]

Okay. I see your point taxguy. He's paying FMV to live there so I'll file the 1065 on 100% of income and expense and he'll get to pay tax on his 1/3 of the profit. Thanks for everyone's input on this!

[TaxGuyBill]

No, because it is rented at Fair Market Value, I think it should be 100% rental use.

[kdhill]

Agreed. They formed this partnership and put the property in it before they hired me. I don't think they consulted any sort of professional when they did it. Now I have the headache of figuring out what to do. If I file it on a 1065 return and treat it as 1/3 personal use, then 2/3 will be rental property. Do I only include 2/3 of the gross income and 2/3 of the expenses on the return? Is the net income that results then divided three ways?

[TaxGuyBill]

Unfortunately, it seems like it needs to be reported on the Partnership return as a rental. If the LLC is officially charging 'rent', that seems like how it needs to be done.

But this arrangement just doesn't makes sense to me. The brother that lives there will be PAYING income tax for living there. That is just bizarre to me. In my opinion it should not have been put in an LLC. That is needlessly complicating things for tax purposes.

[kdhill]

Unfortunately, if the LLC owns the house, the brothers can't report it on page 1 of Schedule E. But you may want to check if the LLC actually does own it.

Yes, the LLC actually owns the property.

Just because they have a LLC and an EIN doesn't automatically mean it is something that needs to be filed on a tax return. I think I would ask more questions to the client about WHY they set up this situation. Is there really a profit motive? Or are the other two brothers just helping out their other brother?

Is the one brother paying Fair Market Rent?

Yes, he's paying fair market value for the rental. There is no partnership agreement. It was just three brothers that inherited a house from their mother and one brother decided he wanted to live in it. I guess he didn't want to buy the other brothers out (or couldn't), I don't know.