Tax treatment of LLC owned building where 2 partners also live

[Connecto]

Hi all,

New client formed an LLC (with three members) and purchased a 3-unit building. Two of the three members moved in and occupy two of the three units and pay slightly below market rent back to the LLC.  The third unit is rented to an outsider at market rent.  Some considerations: 1.  Only depreciate the unit that is rented to an outsider?  2.  Pro-rate 2/3 of all expenses to personal use (distributions)?  3.  Any special considerations at time of sale to account for the business/personal split?  4.  Is there still potential for principal home exclusion if they sell the building down the road?

I am curious how other accountants would handle this.  Thanks all for the great advice!

[qbteachmt]

It appears someone attended one of those "get rich in real estate" courses where you pay a fortune and get lied to.

Is each unit separately titled or deeded? In other words, can they sell the third unit only, at some point?

[Connecto]

The units are not separately deeded and cannot be sold separately.

[sjrcpa]

Does the LLC actually own the property?

[Connecto]

The property was purchased personally by one of the Members.  They are in the process now of re-titling to the LLC.  I am wishing I never answered the phone for this one.  🙂

[qbteachmt]

Here are some of your answers and considerations to discuss with them:

Rental income is taxable, and self-rental income has limitations for expenses, so that is either nondeductible losses or taxable income.

Question 3 doesn't apply if the LLC owns the building. There is no personal ownership.

Question 4 doesn't apply, for the same reason. They stepped off that road by putting the building into an LLC. They turned it into "rental business." That's sad, in a hot market where price appreciation could be substantial and they are going to live there for the minimum time (2 years out of 5 years).

"They are in the process now of re-titling to the LLC."

Instead of this, I wonder if they cannot pursue "subdivision" to condos, so that they are separately titled and own the 2 (each individually), and the LLC owns the one true rental. Assuming you have condos in this region and that this is permissable.

Find out who they consulted and what that cost them, just for giggles.