Husband/Wife Rental Partnership

[Gretel]

I just heard something on "Tax Talk Today", which doesn't make any sense.

They were talking about rental activity and that making the decision not to file form 1065 means filing Sch. C and thus, subjecting this activity to SE tax.

As far as I know having a joint real estate venture with any person you can choose to report your income and expenses on Schedule E. Did something change here or did the IRS person just goof?

[solomon]

I just heard something on "Tax Talk Today", which doesn't make any sense.

They were talking about rental activity and that making the decision not to file form 1065 means filing Sch. C and thus, subjecting this activity to SE tax.

As far as I know having a joint real estate venture with any person you can choose to report your income and expenses on Schedule E. Did something change here or did the IRS person just goof?

That portion of the transcript:

MR. FREEMAN: There was one other change that had to do with husband-andwife
partnerships. It was actually a legislative change that allowed them to simplify the
reporting. And previously they were require to file a Form 1065 partnership return
because even though they are married, there are still two people who are engaged in a
business. So they had to file the Form 1065, essentially make out Schedule K-1s to them,
file the 1065 separate. We had to process it. Then the schedule K-1 income comes back
to their return. Now they can make an election to treat that partnership as a joint venture,
and then they can report their income on two Schedule C’s on their 1040, and not file a
Form 1065.

And we actually made the election as – making the election as simple as we
possibly could by filing the two separate Schedule C’s, you’re deemed to have made the
elections, so there is nothing more to it than that. And the one thing to remember about
that, however, is that on a partnership, if you have, say, a rental real estate activity, which
is often what a lot of these activities are, that income would flow through the 1040 and
not be subject to self-employment tax.

But if you report that same activity as a joint venture on two Schedule C’s, then
that income does become part of the – does become subject to self-employment tax,
which might be a good thing, it might not make any difference. If it’s a loss, like rental
real estate activities often are, especially in the initial years, but it’s one of the important
things to consider before making the election because the election is, once made,
irrevocable without consent of commissioner, so you want to make sure you take
everything into account before you make your decision.

[JoshinNC]

I brought this up in another thread the other day

I just heard something on "Tax Talk Today", which doesn't make any sense.

They were talking about rental activity and that making the decision not to file form 1065 means filing Sch. C and thus, subjecting this activity to SE tax.

As far as I know having a joint real estate venture with any person you can choose to report your income and expenses on Schedule E. Did something change here or did the IRS person just goof?

I have been reading through the new law and can't find where it says that at all. I would like some clarification on this, as I can't find anything that says a purely rental activity between spouses has to be reported on 2 Sch. C's if their other activities that are totally unrelated to the rental activity are reported as such.

If someone here has any further info I'd love to hear it.

[joanmcq]

It doesn't make any sense because RE could always be filed as a JV on the E. Maybe he means IF the H/W RE partnership was filing as a 1065 they could only negate that partnership filing requirement by doing two Sch Cs and making it subject to SE. Or maybe he was blowing smoke out of his butt and didn't know what he was talking about.

[Jesse]

This statement the IRS spokesman said thru me for a loop: "And the one thing to remember about that, however, is that on a partnership, if you have, say, a rental real estate activity, which is often what a lot of these activities are, that income would flow through the 1040 and not be subject to self-employment tax."

I thought maybe there are more joint venture rental RE activities reported on 1065's than I realized. I do not have any that I report on a form 1065 and this had me squirming in my seat thinking I may have been doing the few that I have incorrect?

Also I report H/W rental real estate on the sced E, being from a community property state I am thinking I'm still okay, but still squirming a bit, thinking maybe not? But I don't have a single client that would be better off on 2 schedule C's.

[Bees Knees]

Schedule E instructions, page 3, are very clear that the H&W election is NOT allowed on Schedule E. You can only do it on Schedule C, and that it thus causes SE tax.

The reason is a Schedule E rental is not considered a trade or business activity. It is considered an investment activity for the production of income. The common example is a hotel, which although it is the rental of real estate (room rental), the added services (maid service, room service) make it a trade or business, subject to SE tax.

When Congress wrote the new law on H&W businesses, they wrote it in the context of a trade or business activity, not an investment activity for the production of income.

[Jesse]

Schedule E instructions, page 3, are very clear that the H&W election is NOT allowed on Schedule E. You can only do it on Schedule C, and that it thus causes SE tax.
.................

If a H&W jointly own rental property can't they file one schedule E with their 1040 or should they be filing a form 1065?

[joanmcq]

They can file one Sch E.

[S T]

Schedule E

I believe if h/w joint ownership, just Schedule E,

Form 1065 would only come into play, if the h/w decided to form a LLC or partnership which would then involve the 1065 return and 1040 return and eventually flow through to form 1040 Schedule E.

Sandy

[Bees Knees]

If a H&W jointly own rental property can't they file one schedule E with their 1040 or should they be filing a form 1065?

It depends.

A partnership is when two or more join together to conduct business. A rental activity on Schedule E is generally an investment activity for the production of income. Thus, the regulations allow joint investment activities to elect out of partnership treatment.

Thus, the new law allowing H&W joint business activities to elect out of partnership treatment only applies to Schedule C businesses (and Schedule F), whereas joint Schedule E activities generally always had the ability to elect out of partnership treatment, provided no services were provided in connection with the rental activity.

The Schedule E instructions telling H&W to use Schedule C rather than Schedule E is written in the context of a joint business activity, not a joint investment activity.

Once again, rules designed to simplify things keep getting more complicated. One election allows H&W to elect out of partnership treatment, another allows all investment activities to elect out of partnership treatment, another allows community property H&W to elect out of partnership treatment, and so on and so on...

[Gene V]

Lacerte software users

Schedule E filers

Under General information on input screen 18 (Rental and Royalty Income)
If you check the box joint instead of taxpayer or spouse, this is what pops up in
The Federal Critical Diagnostics. Only way to bypass the msg. Is to check taxpayer
or spouse.

Federal Critical Diagnostics:

Schedule E: According to federal Schedule E instructions, if the taxpayer and spouse jointly own and operate a rental trade or business, they are considered partners in a partnership and should file a partnership return. However, an election may be made under IRC Section 761(f) which allows the taxpayers to file two separate Schedule’s C instead of a partnership return. (It goes on for about 10 more lines).

In the pass, I would check the jointly own box, if they jointly own the property. Now,
in order to send the return electronically, we’ll have to change the check box to taxpayer or spouse.

Check your software and see if you get the same results.

[les grans]

Back to the question...

Well, was the IRS dude blowing smoke or not?
Seems to me there's two questions here, one the correct treatment, and two the software issues.
How does the law read? Where is it?


FWIW, and without any observations on it, here's the offending provision; it's from the U.S. TROOP READINESS, VETERANS' CARE, KATRINA RECOVERY, AND IRAQ ACCOUNTABILITY APPROPRIATIONS ACT OF 2007.


ACT SEC. 8215. FAMILY BUSINESS TAX SIMPLIFICATION.

(a) In General.--Section 761 (defining terms for purposes of
partnerships) is amended by redesignating subsection (f) as subsection
(g) and by inserting after subsection (e) the following new subsection:
``(f) Qualified Joint Venture.--
``(1) In general.--In the case of a qualified joint venture
conducted by a husband and wife who file a joint return for the
taxable year, for purposes of this title--
``(A) such joint venture shall not be treated as a
partnership,
``(B) all items of income, gain, loss, deduction,
and credit shall be divided between the spouses in
accordance with their respective interests in the
venture, and
``(C) each spouse shall take into account such
spouse's respective share of such items as if they were
attributable to a trade or business conducted by such
spouse as a sole proprietor.
``(2) Qualified joint venture.--For purposes of paragraph
(1), the term `qualified joint venture' means any joint venture
involving the conduct of a trade or business if--
``(A) the only members of such joint venture are a
husband and wife,
``(B) both spouses materially participate (within
the meaning of section 469(h) without regard to
paragraph (5) thereof) in such trade or business, and
``(C) both spouses elect the application of this
subsection.''.

(b) Net Earnings From Self-Employment.--
(1) Subsection (a) of section 1402 (defining net earnings
from self-employment) is amended by striking ``, and'' at the
end of paragraph (15) and inserting a semicolon, by striking the
period at the end of paragraph (16) and inserting ``; and'', and
by inserting after paragraph (16) the following new paragraph:
``(17) notwithstanding the preceding provisions of this
subsection, each spouse's share of income or loss from a
qualified joint venture shall be taken into account as provided
in section 761(f) in determining net earnings from self-
employment of such spouse.''.
(2) Subsection (a) of section 211 of the Social Security
Act <<NOTE: 42 USC 411.>> (defining net earnings from self-
employment) is amended by striking ``and'' at the end of
paragraph (14), by striking the period at the end of paragraph
(15) and inserting ``; and'', and by inserting after paragraph
(15) the following new paragraph:
``(16) Notwithstanding the preceding provisions of this
subsection, each spouse's share of income or loss from a
qualified joint venture shall be taken into account as provided
in section 761(f) of the Internal Revenue Code of 1986 in
determining net earnings from self-employment of such spouse.''.

(c) <<NOTE: 26 USC 1761 note.>> Effective Date.--The amendments
made by this section shall apply to taxable years beginning after
December 31, 2006.

[les grans]

Wow!!

Here are five paragraphs from the instructions for Form 1065 that explain the exception from filing Form 1065 that is available to "qualified joint ventures." Frankly, I'm stunned by the explanation of how the interplay with rental activities and SE income/loss seem to work. I think there's something really really wrong here. But Congress did it, it must be right, and it must be good for us...


The five paragraphs (see the startling fourth paragraph re SE income loss from rental businesses...!!):

Husband-wife business. Generally, if you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership and you must file Form 1065.

Exception—Qualified joint venture. Beginning in 2007, if you and your spouse materially participate as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make an election to be treated as a qualified joint venture instead of a partnership. By making the election, you will not be required to file Form 1065 for any year the election is in effect and will instead report the income and deductions directly on your joint return.

To make this election, you must divide all items of income, gain, loss, deduction, and credit between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule C, C-EZ, or F. On each line of your separate Schedule C, C-EZ, or F, you must enter your share of the applicable income, deduction, or loss. Each of you also must file a separate Schedule SE to pay self-employment tax.

If you and your spouse make the election for your rental real estate business, you each must report your share of income and deductions on Schedule C or C-EZ instead of Schedule E. Although rental real estate income generally is not included in net earnings from self-employment, you and your spouse each must take into account your share of the income and deductions from the rental real estate business in figuring your net earnings from self-employment on Schedule SE.

Once made, the election cannot be revoked without IRS consent. If you and your spouse filed a Form 1065 for the year prior to the election, you do not need to amend that return or file a final Form 1065 for the year the election takes effect. However, the partnership terminates at the end of the tax year immediately preceding the year the election takes effect.

[wv112]

So, don't make the election and continue to file the partership return would be the way to go.

[S T]

Not liking this

It would seem from the prior post, that we are going to be able to charge extra fees. So now our h/w rental real estate holdings have to be reported on Form 1065, or the alternative, filing Schedule C and applying SE tax and increasing the tax liability.

Do you think that maybe someone in congress recognized a way to collect more SE tax?

As my husband and myself own rental real estate, I for one guess I will change to a Form 1065, as I certainly don't want to pay extra SE tax, nor do I want to be bound by the election and have to request permission for IRS to revoke.

This is going to be a mess! I guess we will all be applying for new EIN #'s for h/w partnerships on rental property.

Any other insight, do you suppose there will be a technical correction issued in the near future.

How many h/w rentals do each of the TMI posters have, I have quite a few!