Properties Titled Personally but Reported on Partnership 1065

[Margaret Feit]

My husband and I have an LLC with a 50% split in ownership, taxed as a partnership. We own several rental properties, which we run through this LLC. We have separate business bank accounts and credit cards and run all operations of the properties through these business accounts and keep excellent records in Quickbooks, completely separate from our own finances. We file a 1065 that includes all our properties, and all the income flows through to our joint return via the K1.

The trick is that due to the requirements of mortgages, several of the properties are not actually titled to the LLC, but to either my husband or myself or both of us jointly. I'm sure what I ought to have done all along was file the properties titled to the LLC on the 1065 and the ones titled in our names on our own schedule E, but so far I have been doing it all on the 1065, since that's actually how the business is run. It doesn't make any difference in tax owed, since it all flows through to our joint 1040 anyway.

We are anticipating selling one or more of these properties within the next year or two, and I realize that in the year we sell, the gain from sale is going to be reported to the IRS under our personal names, even though the property purchase and ownership has been reported on our 1065. Seems like that would raise some audit flags, since it would appear at a glance that we have a substantial personal gain that we aren't reporting on our 1040 (even though in fact we would be reporting it on the 1065, which would flow through to the 1040). 

I'm trying to determine the best course of action as we plan for sale(s) in the next year or two, and would appreciate any insights. 

1. I could jump through the hoops of amending every 1065 and 1040 since we started buying properties (7 years, I think). At this point it doesn't seem worthwhile to bother with that, since it doesn't actually change anything in taxes owed or paid. 

2. In the year we sell, we might be able to do a quit claim to the LLC just before selling so that the paperwork from the sale shows the LLC as the seller. This would probably complicate the closing process and mortgage payoff, especially if there ended up being any title issues that would now not be covered by title insurance, but it would make the tax return straightforward. We still would be filing incorrectly for our other properties moving forward, though.

3. Can I somehow move the affected properties to our 1040 beginning with our 2021 return so that they are reported under the proper ownership moving forward? If so, I assume I would enter them on the 1040 with the original purchase date and basis and indicate the depreciation already claimed. What would I need to do to remove them from the 1065? Would doing this raise red flags with the IRS?

4. It might be possible to change the MMLLC into a SMLLC, with one of us leaving the partnership and giving our stake in the company to the other. That would eliminate the need for the 1065 and make it so that everything gets reported on our 1040 anyway. In the long run that might be what we end up doing in order to simplify everything, but it seems like a lot of hoops to jump through both from a business structure perspective with the state and from an IRS perspective.

At this point I don't see the LLC structure offering us much protection, since many of our properties are titled in our personal names anyway, and tenants/guests are just as likely to sue us personally as to sue the owner of the property. In spite of my attempts at keeping everything separate in practice, from a legal standpoint I imagine the corporate veil would be pretty easy to pierce at this point! Since we have/need personal mortgages, it seems better to just keep things in our names and have a lot of liability insurance. I also am not concerned with who owns what between my husband and myself or whether there is an equal split of assets and liabilities. I just want to get us into a situation where I am filing correctly and keeping our tax & legal paperwork as simple as possible.

Does anyone have recommendations of the simplest and/or best practice path to take at this point? Either one of the options above or something else I haven't thought of? I appreciate your insights!