LLC and rental property

[natiro]

Well, since it's not tax season yet, and my tax brain is still on vacation, I need some input. . .

Client and his brother have formed an LLC to purchase a condo in another city. Client travels to that city often for work (he works at the University here) and has, up until now, stayed in hotels. The University pays for his lodging expenses.

The University has agreed to pay rent to the LLC for lodging expenses rather than paying for hotel lodging. The nightly charge for the condo will be slightly less than the hotel, although will still be reasonable FMV. Virtually all of this rental activity will be for 7 days or less at a time.

Client and his brother (both LLC members) also intend to rent to themselves, at the same FMV rate, for their personal use of the condo - the use will be occasional and 7 days or less at a time. There may be other rentals, to friends, at the same FMV rate, also for short periods of time.

So, here are the questions:

Do the vacation home rules apply if an LLC owns the property and the LLC members have personal use of the property? (If you have a cite for your answer, I'd appreciate it.)

Since the average period of use is 7 days or less, this would not be a rental activity under the passive loss rules, so the $25,000 special allowance would not be available and the loss would be passive unless the LLC members materially participate. Is this correct? Per TTB they would meet material participation rules under (1), (5), and (6) of the material participation rules. Since neither member would qualify under those 3 rules, the passive losses would be suspended. Is this correct?

Thanks for any insight. Best wishes to all this holiday season.

[thomtax]

Natiro,
I don't have an answer to your question, but I want to throw in something that may possibly be of a concern in this situation. You keep mentioning LLC. Keep in mind that as far as the IRS is concerned, there is no such thing as LLC. You must make a choice of how you are taxed, Sole Proprietorship, Partnership, S Corp, etc. The rules for the method of being taxed would determine how things are handled.

Don't know that this will help you, but needs to be considered.

LT

[Gretel]

I assume it's a partnership LLC, which is default with two members.

My gut feeling is that the LLC status doesn't change the self-rental rules, which say basically that no loss is allowed. By that logic the vacation rental rules also would kick in.

Hope some expert will chime in. I am very interested in this myself.

[Golden Rocket]

Hardly an Expert

...but I will add my two cents. It appears the 14-day-rule is applicable or not, depending on what the definition of a "family member" is for rental purposes. I'm certain it includes children, spouse, parents, and siblings.

If a partnership is elected for tax treatment, then there is no "family", but there might be "related taxpayers." An entity can be a "related taxpayer" even though it is not flesh and blood. I do know that a "related taxpayer" includes siblings. Don't know whether the 14-day rule applies in the case of any related taxpayer or just to family.

I've read Section 267(a), which addresses this more completely than anything else. It's not clear to me, but if I had to make a wager, I would bet that this arrangement must abide by the 14-day rule.

I'll be watching this thread because it has my interest. Gabriele, good to see you back on the board.

[Roland Slugg]

What losses?

Dear natiro

There will probably be no deductible losses since, based on your description, it appears certain that the owners will exceed the 14 days/10% limitation. Thus, the deductions will be limited to rental income each year. See Code §280A(c)(5) and §280A(d)(1). Even when an owner pays FMV rent to the ownership group (in this case an LLC), such use still constitutes "personal use."

In applying the 14 days/10% rule, the days the unit is rented to one of the co-owner's employer ... the university ... count as days of personal use, but those days do not count as days rented. See the example below the heading "Dwelling Unit Used as Home" on page 6 of IRS Pub 527.

Notwithstanding the limitation on deductions, an allocable share of mortgage interest and real estate taxes may be deducted by the co-owners on their respective tax returns ... if they itemize. When calculating the deductible portion of taxes and interest, the IRS and some courts disagree on the formula to be used in making the allocations. The IRS's formula is more restrictive (as you would probably expect) than the one favored by those courts that have disagreed.

[Kram BergGold]

Need to clarify

Natiro,
Here is what I think. An entity whether it is a partnership or corporation will own the property. You say the principals will pay fair rent when they stay there. So I don't see any personal use. If so the vacation home rules do not apply. However, the material participation rules and self rental rules do apply. So assuming material participation if there is positive income it is not passive. If there is neagative income I think it gets deducted.