Author Topic: Converting Rental Properties into a Business - Tax Advice  (Read 745 times)

AccidentalMiser

  • Pencil Stache
  • ****
  • Posts: 659
  • Age: 51
  • Location: SE Tenn
Converting Rental Properties into a Business - Tax Advice
« on: April 12, 2019, 07:14:03 PM »
My DW and I have had a few rental properties over the years.  In 2018, we added two additional units for a total of four.  DW spends a lot of time on renting them, fixing them, etc. etc. and we want to start using Attachment C and keeping track of our business as a business going back to the beginning of 2018.

We should set up an LLC to keep everything separate but haven't done this yet.  The monies have been commingled from rentals and personal finances all along. 

I'd like to simply claim this as my DW's sole proprietorship for 2018 and convert it all over to an LLC this year.  My main question is whether or not I'm opening myself up for an audit.  My other question is about how to account for the ongoing depreciation of the two properties we've been renting all along.  The other wrinkle is that I have several thousand of passive losses which we've been carrying from year to year since they're not deductible beyond rent received unless you are real estate professional (which she is now that we have all these properties.)

I should (and will) ask an accountant about doing this but tax day is nigh and I've been avoiding the inevitable. 

Any input or advice would be greatly appreciated.

Another Reader

  • Magnum Stache
  • ******
  • Posts: 4949
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #1 on: April 12, 2019, 07:45:35 PM »
Be careful with the "real estate professional" determination.  There is a high hurdle to getting that accepted by the IRS and managing a few properties of your own will likely not meet the test nor survive an audit.

In your shoes, I would probably file 2018 as you have in the past and look into whether changes should be made for 2019.  An extension will not help because you do not yet know what the entity under which you need to file.

Papa bear

  • Handlebar Stache
  • *****
  • Posts: 1038
  • Location: Ohio
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #2 on: April 12, 2019, 08:23:46 PM »
Pretty sure schedule C rentals have to be “active” like hotels or short term rentals where you provide some other service, like cleaning.  Otherwise it’s schedule E.

Why do you want to go schedule c? Do you like paying self employment taxes? Or are you trying to take more losses than allowable on schedule e?




Sent from my iPhone using Tapatalk

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1340
  • Age: 59
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #3 on: April 13, 2019, 06:42:36 AM »
Be careful with the "real estate professional" determination.  There is a high hurdle to getting that accepted by the IRS and managing a few properties of your own will likely not meet the test nor survive an audit.

In your shoes, I would probably file 2018 as you have in the past and look into whether changes should be made for 2019.  An extension will not help because you do not yet know what the entity under which you need to file.

+1

Here's a blog post I did a year ago about how the real estate professional status can unravel in an audit:

https://evergreensmallbusiness.com/real-estate-professional-audit-troubles/

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1340
  • Age: 59
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #4 on: April 13, 2019, 06:43:56 AM »
Pretty sure schedule C rentals have to be “active” like hotels or short term rentals where you provide some other service, like cleaning.  Otherwise it’s schedule E.

Why do you want to go schedule c? Do you like paying self employment taxes? Or are you trying to take more losses than allowable on schedule e?


+1 again...

tralfamadorian

  • Handlebar Stache
  • *****
  • Posts: 1210
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #5 on: April 13, 2019, 10:44:18 AM »
+2 everyone's comments

Most people will try to jump through a bunch of hoops to keep their properties in Sch E instead of C (ex: renting an airbnb property for a several month lease in the off season). If you want to establish the LLC and property management business going forward for liability reasons, that's fine but you need to separate your finances to avoid piercing the veil. Since you mentioned you didn't do that for 2018, there's no reason to try and take the SE tax hit of Sch C.

If your SO does not work a FT job and you all think she works enough qualifying hours, then I would start logging all time spent on the rentals with a note of what each time block is for with the idea that you all may need to justify the real estate professional designation to the IRS. I'm not a tax professional but from what I've read on the subject, I do think four properties with a real estate professional designation would be an audit risk.

AccidentalMiser

  • Pencil Stache
  • ****
  • Posts: 659
  • Age: 51
  • Location: SE Tenn
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #6 on: April 19, 2019, 07:27:16 PM »
I didn't do it, based on reading and your advice.   Thanks very much.  Not worth the audit risk although DW definitely spent over 750 hours on our rentals last year and it was her main occupation.

I'll roll those passive losses forward one more year!

Thanks again.

AM

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 4771
  • Age: 34
  • Location: Seattle, WA
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #7 on: April 22, 2019, 08:43:39 AM »
Pretty sure schedule C rentals have to be “active” like hotels or short term rentals where you provide some other service, like cleaning.  Otherwise it’s schedule E.

Why do you want to go schedule c? Do you like paying self employment taxes? Or are you trying to take more losses than allowable on schedule e?

Not necessarily relevant to the OP's case, but couldn't a FIREd person with kids at home potentially benefit from having a rental property treated as a business rather than as a passive investment? Depending on the amounts involved, they could potentially qualify for an earned income credit that would exceed the self-employment tax owed. Lots of other things would probably have to line up for this to work though.

Papa bear

  • Handlebar Stache
  • *****
  • Posts: 1038
  • Location: Ohio
Re: Converting Rental Properties into a Business - Tax Advice
« Reply #8 on: April 22, 2019, 09:50:23 AM »
Pretty sure schedule C rentals have to be “active” like hotels or short term rentals where you provide some other service, like cleaning.  Otherwise it’s schedule E.

Why do you want to go schedule c? Do you like paying self employment taxes? Or are you trying to take more losses than allowable on schedule e?

Not necessarily relevant to the OP's case, but couldn't a FIREd person with kids at home potentially benefit from having a rental property treated as a business rather than as a passive investment? Depending on the amounts involved, they could potentially qualify for an earned income credit that would exceed the self-employment tax owed. Lots of other things would probably have to line up for this to work though.

There would be a few situations I could see that would also be a benefit.  If you need social security income to meet your 40 quarter requirement, need earned income for childcare deduction, want to put money in an IRA, etc.  but those would all need some math to figure out if it would be a benefit or not. 


Sent from my iPhone using Tapatalk