How to deal with expenses paid out of pocket?

[David Sisson]

Hi, I'm a new owner of a distressed commercial property. 

The property is owned by a LLC. I own the LLC outright. I've set up a separate bank account for the LLC, and am tracking all expenses through quickbooks.

I've been doing some work on the property (repairs and improvements) and paying out of pocket for these expenses (from my personal bank account). I know that for 2017 that my expenses will eclipse my income from the property, because there's only 1.5 months left in 2017 and since the property is distressed, I'm getting zero cash flow while we rehab. I was planning on entering these expenses as items to reimburse myself for (IE: pay my personal account back from the business account), but since the expenses will be higher than the income, I can't reimburse them in 2017.

How do I deal with this? Do I roll these expenses over to 2018? Do I show them as investment in the property and show a loss for 2017? 

[Michael Plaks]

@David Sisson

As often happens, your question mixes several separate issues together.

1. One tax return or two? If you own the LLC outright, you might decide to treat it as a disregarded entity. In this case, you would report your property the same way as if it was owned directly by you: on Schedule E. Business and personal are combined on a single tax return. The whole concept of separate accounts, reimbursement etc becomes blurry, and drawing a line between personal and business is kind of optional.

2. Paying someone else's bills. Assuming that you do separate the LLC from yourself and file 2 tax returns, the two become "strangers." In your scenario, you are paying expenses of someone else, the LLC. This is not normal. (If it is, then I have some bills for you to cover.)

3. When would you ever pay someone else's business bills? When you're either investing in this business or lending to this business. In both cases you first give the business cash, and the business pays its bills with your cash. You never pay the business bills directly in lieu of an investment or loan.

4. For the business to deduct en expense, it must both incur and pay the expense. The LLC did incur the expenses, since it owns the property, but it did not pay them, you did! Consequently, the LLC cannot deduct them.

5. To fix the problems described in #3 and #4, the LLC should reimburse you for these expenses. This way, the expenses become business expense of the LLC. There should be a written reimbursement policy and actual reimbursement: detailed report of expenses and transfer of money.

6. Since the LLC does not have cash, it can only reimburse you with an IOU. The transaction still should be documented as reimbursement, in order to make the expenses deductible by the LLC.

7. The IOU should appear as a Current liability (Short-term notes payable, Expense reimbursement, or a similar account), and the corresponding expense either as an expense (if deductible) or a fixed asset (if capitalized).

8. Timing. If reimbursement does not happen until 2018, then the LLC cannot expense or capitalize it in 2017. If this is the desirable result, then you can delay reimbursement. Be careful however, because excessive delays can become a problem.

9. Insufficient income in 2017 shall not prevent qualified expenses from being deducted. Even if your losses end up limited, the overflow will transfer to 2018 automatically. 

10. ... there's more, but I'm tired :)