rent vs business use of home

[kaynik]

Had anew client this week whose prior return preparer let the partnership write checks to taxpayer in the amount of 1500 month, 18000 year vs business use of home. I have access to 2003, 2004, 2005, where this one person LLC was filed as a partnership with 18000 rent paid, personal return shows 18000 rental income. 2006 preparer filed llc as Schedule C but still claimed the 18000 rent, and carried rents to schedule C less nearly 1000 as utilities no depreciation or taxes. Full amount of mtg interest and txs carried to schedule A I am filing as Schedule C but I dont like the rent deal - I say No - relationship too close am I being too coservative? many years and first time I have run into this -

[Bees Knees]

Applicable rules:

1) A single member LLC cannot file a 1065 as a partnership. It is either a Schedule C or the LLC can elect to be taxed as a C corporation or an S corporation.

2) IRC §280A(c)(6) says if you rent your office in home to your employer, you pay tax on rental income, but you get zero deductions attributed to the business use of your home. A partner is not an employee of his/her partnership, and an LLC member is not an employee of his/her LLC. So this rule does not apply to your situation.

3) IRS Pub 535 says: “Rent is any amount you pay for the use of property you do not own.” That rule prevents a Schedule C business from shifting self employment income over to Schedule E.

The way to get around number 3 above is have a separate business entity pay rent to the owner. For example, an S corporation pays rent to its sole shareholder for use of a commercial building. This is a technique used to pull profits out of the S corporation without having to subject it to payroll taxes.

Can this apply to your situation? Yes and no. The LLC is generally a separate entity that can pay rent to the owner for use of property. However, under federal tax rules, a single member LLC is a disregarded entity. That is why the single member LLC files a Schedule C rather than a corporation return, unless the LLC elects to be taxed as a corporation.

In my opinion, if the LLC is a disregarded entity for federal tax purposes, then the single member of that LLC is treated just like a sole proprietor and cannot rent property to himself.

If you have the LLC elect to be taxed as a corporation, the single member becomes an employee of his corporation, and any rental of his home office to his corporation becomes non-deductible personal expenses.

One possibility may be to have the LLC have two members, husband and wife (assuming taxpayer is a he and he is married). It could be 99% / 1%, as long as there are at least two members, so the LLC can file a 1065 as a partnership. Then the rental arrangement would work.

[kaynik]

business use of home

thank you I needed reference to reinforce and sort out my thousghts

[jsamans]

Self-Rental Implications

This thread is now six years old, but since I came across it while researching a similar question, it's worth adding some information to bring it up to "current" standards -- specifically, the implications of self-rental.

Whereas rent is typically a passive activity, "if a taxpayer rents property to an activity in which the taxpayer materially participates, any net rental income for the year is treated as nonpassive income, while any loss is treated as passive. The effect of this rule is to not allow self-rental income to offset passive losses." (TTB 7-10)

That essentially means that paying higher-than-market rent will be of no value to a partnership or partnership-taxed LLC, because the same income that would have been active if made as a guaranteed payment will be treated as active despite coming from rent.

[nkustura]

Partnership Paying rent to partner

I have a client who is a partner in a two member partnership (his brother is also a partner). My client is general partner in the partnership and he does most of the work for the partnership. Over the years, partnership has been paying my client $1000/mo for rent of partner's personal residence as office space. Partner lives in the same house that's collecting rent from the partnership. Partner has been including $12k as rental income on his personal return, however no expenses have been deducted from rental income such as home insurance, utilities, depreciation, personal property tax, mortgage interest, etc.

My initial thought is that personal residence expenses such as the ones listed above should be allocated to the part of the house that's rented to partnership and deducted on schedule E, but I am not sure if there are any restrictions due to the fact that it is personal residence being used as office space, etc.

Have any of you come across situation like this? How would you treat it?

Thanks

[jsamans]

Have any of you come across situation like this? How would you treat it?

The partnership can pay your client $1000/mo as a guaranteed payment and amend the partnership agreement to require that he provide his own office space on a non-reimbursed basis, after which the client can deduct expenses associated with the business use of his home (i.e. prorate the mortgage, utilities, insurance, depreciation, etc. based on percentage use) as unreimbursed partnership expenses (UPE) on Schedule E (see TTP 20-7).

Handling things in this manner provides the same $1000 (which, because of self-rental rules, will be active income in either case) while also accounting for the expenses, and it bypasses the complexity of self-rental.