Question on an operating LLC being repurposed to manage real estate:

Suppose one has a regular small business LLC that has significant net operating loss carry forwards for tax purposes. If one bought a vacation rental property and "hired" the LLC to manage the process, without having to buy the property itself - the LLC would collect all rent, and pay all operating expenses (management fees, utilities, property taxes, maintenance & upkeep, etc.) and pay no rent to the owner (and making a decent profit every year). The LLC should clear a decent profit every year. Let's say the loss carry-forwards would be exhausted in 8-10 years, at which point the property owner might sell (and then shut down the LLC). Would this pass muster with the IRS? Or would the LLC have to have skin in the game with equity?

How does the LLC have net operating loss carryovers, unless it files as a C corporation? Or are you saying the losses the LLC incurred created an net operating loss carryover personally?

one safe place said:

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How does the LLC have net operating loss carryovers, unless it files as a C corporation? Or are you saying the losses the LLC incurred created an net operating loss carryover personally?

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LLC filing as C-Corp.

I bleed maroon said:

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one safe place said:

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How does the LLC have net operating loss carryovers, unless it files as a C corporation? Or are you saying the losses the LLC incurred created an net operating loss carryover personally?

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LLC filing as C-Corp.

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Gotcha

I bleed maroon said:

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Question on an operating LLC being repurposed to manage real estate:

Suppose one has a regular small business LLC that has significant net operating loss carry forwards for tax purposes. If one bought a vacation rental property and "hired" the LLC to manage the process, without having to buy the property itself - the LLC would collect all rent, and pay all operating expenses (management fees, utilities, property taxes, maintenance & upkeep, etc.) and pay no rent to the owner (and making a decent profit every year). The LLC should clear a decent profit every year. Let's say the loss carry-forwards would be exhausted in 8-10 years, at which point the property owner might sell (and then shut down the LLC). Would this pass muster with the IRS? Or would the LLC have to have skin in the game with equity?

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The LLC has nothing to rent so the rent belongs to the owner of the property. If the IRS were to look at the arrangement, and took notice of what you are doing (parking rent inside an entity with NOLs rather than the individual (the owner of the property) paying taxes on the rent, it might get challenged.

The LLC, since it does not own the property, is not entitled to take a depreciation deduction, depreciation would be taken by the owner, but then the owner has no rental income. Since the property itself is being rented, the depreciation allowed or allowable (i.e., not deducted) reduces the basis and thus increases the gain on the ultimate sale.

Also, you might want to discuss personal holding company status and taxation with someone who has dealt with that and let them advise you on the consequences and how to avoid paying that tax and the tax cost of doing so (e,g, paying dividends from the C corporation).

I am sure there are many other things that you should look into and consider, but those are what popped into my mind, as old and worn out as it is, lol.

one safe place said:

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I bleed maroon said:

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Question on an operating LLC being repurposed to manage real estate:

Suppose one has a regular small business LLC that has significant net operating loss carry forwards for tax purposes. If one bought a vacation rental property and "hired" the LLC to manage the process, without having to buy the property itself - the LLC would collect all rent, and pay all operating expenses (management fees, utilities, property taxes, maintenance & upkeep, etc.) and pay no rent to the owner (and making a decent profit every year). The LLC should clear a decent profit every year. Let's say the loss carry-forwards would be exhausted in 8-10 years, at which point the property owner might sell (and then shut down the LLC). Would this pass muster with the IRS? Or would the LLC have to have skin in the game with equity?

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The LLC has nothing to rent so the rent belongs to the owner of the property. If the IRS were to look at the arrangement, and took notice of what you are doing (parking rent inside an entity with NOLs rather than the individual (the owner of the property) paying taxes on the rent, it might get challenged.

The LLC, since it does not own the property, is not entitled to take a depreciation deduction, depreciation would be taken by the owner, but then the owner has no rental income. Since the property itself is being rented, the depreciation allowed or allowable (i.e., not deducted) reduces the basis and thus increases the gain on the ultimate sale.

Also, you might want to discuss personal holding company status and taxation with someone who has dealt with that and let them advise you on the consequences and how to avoid paying that tax and the tax cost of doing so (e,g, paying dividends from the C corporation).

I am sure there are many other things that you should look into and consider, but those are what popped into my mind, as old and worn out as it is, lol.

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That's a GREAT start - Thanks! My view is that the owner's purpose is to solely achieve a longer-term capital gain on the property as a passive investor. If that MUST include depreciation, so be it, otherwise, it could be foregone, if that's allowed. In effect, the owner gives the LLC the right to rent the property for its' own benefit, in return for maintaining and paying virtually all carrying costs on the property (the owner saves all of their time and expense). Now, if the same person is in control of both, I can see where it might get dicey with the IRS (as you note). Theoretically, the LLC "staff" may spend some combination work/fun time at the property periodically, as well. This was run by a small business CPA, and they seemed to think it made sense, but I remain a bit skeptical.

The deciding issue may be that this isn't super major bucks at stake, so the juice may not be worth the squeeze, but it would be a shame for $xxx,xxx in NOLs to be "wasted".

Any other structures spring to mind?

You can forego any expense, i.e. not take a deduction that you are entitled to. The downside with depreciation not taken is that you must still reduce the basis of the property whether you deducted the depreciation or not. So if you bought a property for $500,000, took no depreciation over the next 30 years in which it was rented, then sell it for $2,000,000, the property would be fully depreciated so the basis would be zero and you would have the full $2,000,000 gain to report.

You might want to consider, or have the CPA run the numbers for you, in which you report all the rental activity in your personal return like an ordinary rental property, but hire the LLC to do the things you said (collect rent, pay bills, remit to you any excess funds, manage the property, get bids on insurance, protest taxes, things a management company would do. Then you pay the LLC a management fee for those services, and the management fee would be absorbed by the NOL carryovers. That fee would have to be reasonable in amount to avoid potential problems, but the more that it does the higher that fee could be. In other words you pay them to do everything, but the activity is run through a personal bank account, not an LLC bank account.

Setting it up that way means you get the benefit in your personal return of the depreciation so the tax paid upon the sale is somewhat less painful since you did save tax on the depreciation taken over the years. In the example above, you would still have the $2,000,000 gain to pay tax on, but you would have gotten the benefit of the $500,000 in depreciation deductions and tax savings due to that depreciation over they years.

Discuss with your CPA the personal use, the fun time thing you mentioned. The amount of that use can impact how the property is treated and can limit deductions.