How to deal with Property purchased for use in LLC

[equinecpa]

I'm doing a couple of returns and have run into a conundrum.

My clients (husband and wife) run an LLC with her father (varying interests in llc - I think 35%, 35% and 30%).

In 2006 they purchased a property , I believe in all 3 of their names. The LLC runs its business out of this property. Can the indviduals lease this property to the LLC or would that be considered self-rental? I'm thinking they can as the property is co-owned but not an LLC asset.

The LLC haasn't been making rent payments, but does make the payments on the mortgage. I haven't seen the closing documents yet to verify title.

Carolyn

Still working on 06 returns yikes!

[S T]

Self Rental

If the LLC is renting from the Members, that are "Active" in the LLC then I believe it is a self rental, whereby the rental of the property becomes non-passive and losses are not allowed.

Wouldn't the mortgage payments be classifed as rents on the LLC return, and the Members report the income on their Schedule E return?

From: http://www.irs.gov/businesses/small/...146835,00.html

LAW: Under Reg. § 1.469-2(f)(6), if a taxpayer rents property to a business in which he materially participates, net rental income is non-passive. Stated differently, rental income from self-rented property cannot be used to trigger allowance of passive losses on Form 8582. This rule does not apply if there is a written binding contract entered into before 2/19/1988.

Sandy

[cpadan]

If

Wouldn't the mortgage payments be classifed as rents on the LLC return, and the Members report the income on their Schedule E return?

That is how I would do it.
Dan

[Gretel]

I cannot see how the LLC can take a deduction for mortgage payments on a mortgage for property they don't own. Isn't this the same thing as one individual making a mortgage payment for another?

Besides, I would be concerned with liability issues (this was the reason for having the LLC is the first place) in co-mingling funds. They should have a rental agreement in place also.

I get very sensitive on these types of transactions and try to cross all t's.

[Matt Sova]

mortgage payments

A business runs out of a building owned by a separate entity.
The separate entity is owned by the same owner(s) of the business.
Mortgage payment on building = $1500/month and is P/I only.
Business is the only tenant and occupies 100% of the building.
Business pays Property Taxes, Insurance and Maintenance on the building when due as a triple net lease.

Now you could have the business make a payment of $1,500/mo to the rental entity and the entity then makes the mortgage payment. The business then has 18k in rent expense and the entity then has 18k in rent income with mortgage interest and depreciation as a deduction. This would require the rental entity to have a bank account and bank fees as well.

What normally happens is the business makes the payment directly to the bank and expenses it as rent - 18k. The rental entity picks up 18k as rent income and deducts the mortage interest and depreciation.

Net result - same thing with fewer hassles and no bank charges.

Matt

[John of PA]

Separate Management Company

I would suggest the LLC be a separate Real Estate Management Company. The property is in the name of the individual. The LLC collects the rents and pays all expenses, and the owner of the real estate (and owner of the LLC) draws from the LLC whatever cash is left over. That cash is used to pay the mortgage each month (and maby taxes), the mortgage being paid directly by the owner. Thus the owner has the interest deduction, no problem. Also with this setup (which is very common), if there is a lawsuit by a tennant, they cannot touch the Real Estate (as the LLC is the party to the leases).

[cpadan]

As I undestood it, this is an after the fact situation. Company has rent expense for mortgage and propety taxes which individuals recognize as income; they deduct interest, property taxes and depeciation.

Dan

[equinecpa]

Thanks all - I planned on calling the mortgage payments rent, and then reflecting the rent received on the 1040 with the interest/depreciation as a deduction. I was just worried about the self rental issue.