What happens to mortgage interest deduction in an LLC

Brendon Woirhaye

Rental Property Investor · Whittier, CA · Member since 2014 · 324 posts · 268 votes

8y

Your cost of financing (mortgage interest) is considered an expense, and would be deducted as a business expense within the LLC - it is not handled as a home mortgage interest deduction. Principal paid down would not be a deductible expense.

Depreciation on the property is also considered as an expense, even though cash does not leave the LLC to pay for it until the property is sold (it would then be recaptured at capital gains rates if you didn't 1031 exchange it).

2 Reply

Wayne Brooks

Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes

8y

A side note, at $240/yr for insurance it doesn’t seem this would be a comprehensive policy that would cover liability (like if one of Your pipes breaks, toilet/tub overflows and does substantial damage to a lower unit) And replacement/repair of similar damages “from the walls in” for your unit.

3 Reply

Paul Allen

Financial Advisor · Virginia Beach, VA · Member since 2017 · 502 posts · 508 votes

8y

Seems like you are considering forming a 4-member LLC. The IRS will treat this as a partnership for tax purposes (unless you choose otherwise, and you DO NOT want to choose otherwise if you are leasing the property and collecting rents).

The partnership will file a form 1065 information return every year and deliver each partner a Schedule K-1 which is created as part of the 1065 preparation. The K-1 tells each partner (and the IRS) what each partner's share of the gains and losses from the partnership were. Those are recorded on your individual tax returns (form 1040) on Schedule E page 2.

Assuming the 4 partners in the partnership each receive 25% of the income and expenses, then each partner will deduct 25% of the mortgage interest expense on his/her individual tax return. That mortgage interest will make it to your individual returns via the K-1(s) delivered to the partner(s) after the partnership files its 1065 return.

Best of Luck with Your Real Estate Investing!

3 Reply

Al D.

Investor · San Francisco, CA · Member since 2017 · 303 posts · 327 votes

8y

Being that this is your first deal, you didn’t ask, and no one has brought this up along with their good answers to your question: Have you found a lender willing to lend to an LLC/other business entity? Also, your assumed interest rates may be too low today for a condo with 20% down, even in Manhattan.

OP

Miami, FL · Member since 2017 · 51 posts · 14 votes

8y

Originally posted by @Wayne Brooks:

A side note, at $240/yr for insurance it doesn’t seem this would be a comprehensive policy that would cover liability (like if one of Your pipes breaks, toilet/tub overflows and does substantial damage to a lower unit) And replacement/repair of similar damages “from the walls in” for your unit.

Wayne,

I budgeted 20 a month based on the fact that this is a condo and things like the plumbing are usually covered by the condo board and the HOA fee but to be honest what I had not considered was damage to the interior of my unit not being covered in the event of such happenings

OP

Miami, FL · Member since 2017 · 51 posts · 14 votes

8y

Originally posted by @Al D.:

Being that this is your first deal, you didn't ask, and no one has brought this up along with their good answers to your question: Have you found a lender willing to lend to an LLC/other business entity?

Also, your assumed interest rates may be too low today for a condo with 20% down, even in Manhattan.

Thats a fantastic point. I have not locked down the lender bit and don't really understand the specifics of how getting a loan for an LLC work. Was figuring I could borrow in my name then transfer into the LLC. Let me know if thats too optimistic. Regarding the interest rate piece I am basing it on my excellent credit score and the unit would be in charlotte NC. Let me knoe if that number still seems far too low

OP

Miami, FL · Member since 2017 · 51 posts · 14 votes

8y

Originally posted by @Paul Allen:

Seems like you are considering forming a 4-member LLC. The IRS will treat this as a partnership for tax purposes (unless you choose otherwise, and you DO NOT want to choose otherwise if you are leasing the property and collecting rents).

The partnership will file a form 1065 information return every year and deliver each partner a Schedule K-1 which is created as part of the 1065 preparation. The K-1 tells each partner (and the IRS) what each partner's share of the gains and losses from the partnership were. Those are recorded on your individual tax returns (form 1040) on Schedule E page 2.

Assuming the 4 partners in the partnership each receive 25% of the income and expenses, then each partner will deduct 25% of the mortgage interest expense on his/her individual tax return. That mortgage interest will make it to your individual returns via the K-1(s) delivered to the partner(s) after the partnership files its 1065 return.

Best of Luck with Your Real Estate Investing!

Paul,

This is exactly the information I was looking for, thanks so much to you and everyone else chipping in. Is it still ok to make monthly distributions through the LLC or would everyone recommend an annual distribution?.

Paul Allen

Financial Advisor · Virginia Beach, VA · Member since 2017 · 502 posts · 508 votes

8y

Thanks @Adrie Moses-bailey

The timing/frequency of the distributions generally does not impact your tax situation with a partnership. The income from the partnership is taxable to the partners even if you leave it all in the partnership's bank account and don't distribute any of it. Because the partnership itself does not pay taxes, the income from it passes through to the partners in the year it is earned, regardless of whether it is withdrawn from the bank and handed to a partner.

Distributions matter when it comes to tracking a partner's capital account. This is an important concept from a business standpoint. It can become a significant tax issue if your partnership gets large enough that partner capital accounts get reported to the IRS. (I have no idea what NY law requires on that matter, btw.)

You would likely be well-served to get an accountant involved early.

3 Reply

Wayne Brooks

Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes

8y

@Adrie Moses-bailey To be clear:

The assocition is typically responsible for 'common" plumbing, inside a common wall, etc.

You are responsible for interior plumbing, toilet feed line, sink feed lines, etc. If one of these breaks, toilet/tub overflows, etc. then You are responsible to any damages to another/lower unit. I've seen many $20k plus repairs for this.

OP

Miami, FL · Member since 2017 · 51 posts · 14 votes

8y

Originally posted by @Wayne Brooks:

@Adrie Moses-bailey To be clear:

The assocition is typically responsible for 'common" plumbing, inside a common wall, etc.

You are responsible for interior plumbing, toilet feed line, sink feed lines, etc. If one of these breaks, toilet/tub overflows, etc. then You are responsible to any damages to another/lower unit. I've seen many $20k plus repairs for this.

Thats good to know and I should definitely look at a better insurance policy for it then and calc that in

Al D.

Investor · San Francisco, CA · Member since 2017 · 303 posts · 327 votes

8y

Adrie Moses-bailey (now the name thing is working:) If you are purchasing this property with three other friends, and especially if it may be the first such endeavor for even just one of you, I hope that you will have a solid partnership agreement that outlines all expectations and possible contingencies. One contingency to consider is what would happen if the lender were to find out that you, as the original borrower, turned around and transferred title to an entity that involves something other than your own name. The lender may decide to accelerate your loan. That is the worst case, I imagine. You may also luck out and never have an issue. Only you can figure out if the situation is worth the risk. Assuming zip 28226: 740+ FICO, 30-yr fixed, 0 points, 20% down on a $99k investment condo can be had at 6.375% today. But 25% down can bring the rate down to as low as 5.375% (PennyMac.) That is for a conforming loan that would have to be taken out by a living person. Remember that rates change all the time. I am not familiar with that market, but there is a chance that some local lender, like a credit union or a regional/community bank, may have better terms. There is also a chance of a non-confirming loan - like a “portfolio loan” - from such a lender, where they may lend to an LLC. Although, the rate and other terms would likely be worse. Good luck.

Michael PlaksPro Member

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

8y

@Adrie Moses-bailey

While @Paul Allen very well explained what would happen when/if you form a 4-way LLC/partnership, I urge you to consider if you can avoid this route altogether.

The best possible structure for a project like yours (for a great many reasons, taxes being just one of them) is to keep it as 100% your deal. Your buddies should be your lenders, as opposed to co-owners. They can be compensated based on any formula you agree on, including some form of profit split.

You will bear 100% of the risk, but you will have 100% of the decision power - something most new investors mistakenly undervalue.

And you will also eliminate 90% of potential problems down the road.

4 Reply

OP

Miami, FL · Member since 2017 · 51 posts · 14 votes

8y

Originally posted by @Michael Plaks:

@Adrie Moses-bailey

While @Paul Allen very well explained what would happen when/if you form a 4-way LLC/partnership, I urge you to consider if you can avoid this route altogether.

The best possible structure for a project like yours (for a great many reasons, taxes being just one of them) is to keep it as 100% your deal. Your buddies should be your lenders, as opposed to co-owners. They can be compensated based on any formula you agree on, including some form of profit split.

You will bear 100% of the risk, but you will have 100% of the decision power - something most new investors mistakenly undervalue.

And you will also eliminate 90% of potential problems down the road.

Micheal that is a fantastic point I had not considered. Taking a private loan on the down payment is an option and does have the benefits you mention. I imagine the deal has to be even better though to pay the cost of capital on the equity going from 0% to whatever interest rate I work out with friends but the ROI for me would be higher due to the much greater leverage. So too then is the risk.

Michele G.

Ann Arbor, MI · Member since 2017 · 109 posts · 52 votes

8y

Adrie Moses-bailey I had a washer shut off fail a few weeks ago in one of my condos. It was my responsibility since it was specific to my unit not common plumbing. Since the tenant had left for the weekend he didn’t notice it until he came home. The entire main floor got wet. Luckily it hadn’t reached up to the drywall yet. My point is...make sure you have enough insurance to cover a loss like that. Replacing the flooring & the minor drying needed cost us $5000. Insurance covered all of it except for the deductible. If we had drywall damage the cost would have been much higher. Make sure you know the amount of “walls in” coverage your agent is quoting you so you are properly covered.

2 Reply

Michele G.

Ann Arbor, MI · Member since 2017 · 109 posts · 52 votes

8y

As for mortgage interest: the interest is tax deductible as a business expense in an LLC. The principal part of the mortgage payment is not deductible.