Inheriting RE - taxes, ownership, advice in General

[Aubrey P.]

Although the tax reform bill is still in conference and hasn't been passed, and the final bill will require study in conjunction with a discussion with a real estate savvy CPA to understand its implications on my particular real estate question, I am hoping someone on this thread can weigh in with some general advice. Please excuse the long post.

My close friend's parents are "buy and hold" small time landlords with a 2 commercial (1 building has three units and the other is one contiguous space) and 4 residential properties they rent out. These properties are all held jointly by their parents in their parent's names only, but each property has good liability insurance and umbrella policies.

The parents structured ownership in their name only this way partly because they were not convinced that since they handle maintenance, tenant vetting, etc themselves., that LLCs were worth setting up for each property. That there wouldn't be a huge benefit to it. With such hands on management the corporate veil protection of an LLC could be easily pierced was part of the reasoning. However, one of the residential buildings is currently held in a partnership with the parents, and their two siblings.

There are no separate bank accounts for these properties and money is just being deposited into one account., which I think needs addressing. These buildings bring in good rent, are centrally located in a major city, are well kept, and were a side business for the parents when they were working. This year they retired and are living on rental income from these properties. They've never really been strict about all the itemized deductions as landlords they could be taking (travel expenses, repairs etc.) or used spreadsheets to track things like rent. They were basically accidental landlords, who worked hard at their other professions, who were lucky to have good tenants.

These building will pass down to the sibling ( my friend) and his brother as inheritance and will be 50/50 ownership. They would like to continue on managing them. The siblings are trying to get up to speed on being future landlords. They've created excel spreadsheets to track expenses and rent. Encouraged separate bank accounts. Kept receipts for maintenance to itemize deductions etc., but I am curious as to some suggestions for the most tax advantageous methods they should be transferred the siblings.

Should ownership be transferred via forming partnerships (or LLCs? or S Corps?) for the all properties currently held in name only while the parents are living or should they just wait until after their parents have passed to assume ownership (the properties are held in a revocable trust where the siblings would simply inherit them)?

In any case, once these properties are theirs solely, should they continue to be held in name only but with high insurance polices as they are now? Or in an LLC(s)? Or Series LLC? Or in an LLC elected to be taxed as an s corp? Basically what would be a tax advantageous set up?

Any tips on property management or other way for them to get up to speed on inheriting these buildings. and how they should prepare themselves, both from a management and tax perspective would be appreciated as well.

I know a CPA is going to need to wade into the nitty gritty, as this is a complex set of questions, but any general advice is appreciated. Thank you.

[Ashish Acharya]

Aubrey, 

Q; There are no separate bank accounts for these properties and money is just being deposited into one account. Which I think needs addressing.

• Answer – I see you say this needs addressing because they are commingling the funds. I too think keeping separate accounts makes life easier for a bookkeeping but is not necessary for them. Just keeping a good record of the cash movements is fine. However, commingling is most relevant and necessary when you are conducting a business via business entities. Right now, they are not.
• Not commingling a fund right now is just going to be good business practice and easy for bookkeeping and is not going to impact you from liability perspective even if you were actually commingling.

Q: These building will pass down to the sibling (my friend) and his brother as inheritance and will be 50/50 ownership …. Encouraged separate bank accounts.

1. Answer- Yeah, once they start doing a business via entity, separate bank accounts as you suggested is required.

Q: Should ownership be transferred via forming partnerships (or LLCs? or S Corps?) for the all properties currently held in name only while the parents are living or should they just wait until after their parents have passed to assume ownership (the properties are held in a revocable trust where the siblings would simply inherit them)?

• If the property is gifted, there is no stepped-up basis, which would be beneficial to the brothers.
• The best way would be to acquire the property via inheritance so that bothers get stepped up basis.
• We can make this all complicated with trust and stuff if needed.
• Sometimes State transfer taxes can be minimized by transferring property to a single-member LLC and then selling the LLC interest instead of the property. This works in a state that provides for only a nominal fee or tax on the transfer of property to a partnership or LLC when the transferor controls the transferee entity.

Q: In any case, once these properties are theirs solely, should they continue to be held in name only but with high insurance polices as they are now? Or in an LLC(s)? Or Series LLC? Or in an LLC elected to be taxed as an s corp? Basically what would be a tax advantageous set up?

• Answer: LLC is more of an asset protection vehicle rather than the tax saving. However, there are some tax advantages for choosing LLC over S-crop for rental activities.
• The main reason people elect S-crop in RE business is to avoid SE taxes( self-employment taxes). When you flip a property, the gain is treated as ordinary income so have to pay SE tax. However, rental income is passive income (unless you provide substantial service like cleaning or maid service, seen in AIRBNB activity) and you don’t have to pay SE tax on rental passive income, so electing S-corp for rental portfolio does no good. Also
• 1) If you intend to hold rental under S-corp for a long time, then you can elect S-corp. however, if you do not, transferring an asset from S-corp to partners for various reason is a taxable event. (You transfer property from Scorp to you, you don't receive any money, but your taxes might be thousands of dollar if there was substantial gain when you transfer.) Whereas in LLC, transferring asset is not a taxable event, it normally just reduces partner's basis in the partnership.
• 2) If you elect S-corp, and if ever wanted to draw let's say $5000k from S-corp for personal use (vacation), you have to distribute the proportionate amount to all other partners of the S-corp too. Whereas in LLC, each partner can withdraw what they want and only his/her basis would be impacted.
• 3) In S-corp, you act as both employee and investor. So you cannot deduct any loss greater than your investment or basis in S-corp just like when you buy stocks in the public company, the max you can lose is your money you invested in the stock. Whereas in LLC there is no limitation because the business loss and gain are pass through. There are some exceptions regarding at-risk concepts.
• Also, let’s not forget about the all the payroll compliance and other compliance for S-crop.

Hope that was helpful.