Can you deduct depreciation if your S-corp manages your property?

Question

If you have a rental and set up an S-corp that will take 100% of the profits from the rental (can you do this to begin with? to avoid self-employment tax), and the S-corp's income will pass over to you, can you still deduct the depreciation of your rental? You own the rental in your name, NOT in the S-corp, and you have the mortgage of the rental in your name.

Carl Fischer · Answer

@Ellie Narie

See all the hoopla CPAs have to do. Throw a couple ideas out there, Pay them and you will get a solution and you can keep working the real estate  and make money.

Ashish Acharya · Answer

@Ellie Narie ,

The rental income is not subject to SE taxes, so you really dont need S-corp.

People use LLC for rentals as an asset protection vehicle. Not saying you should get one. There are limited tax benefits form LLCs. You can accomplish same protection with good insurance.

Also, no matter how you structure your entity, you are always deemed to have taken the depreciation by IRS. Meaning,  if you dont take it, you lose it. When you sell the property, you have to pay taxes on the recaptured depreciation even when you didn't take it.

Michael Plaks · Answer

I'm not in agreement with @Ashish Acharya and @Brian Schmelzlen on self-employment tax for short-term (7 days and under) rentals.

We all agree that there's no self-employment tax for rental activities. However, two specific situations are NOT considered rental activities and therefore are NOT exempt from self-employment taxes.

These two situations are:

#1:  7 days or less - regardless of substantial services provided or not

#2:  30 days or less  if substantial services are provided (effectively making it relevant only for 8-30 days)

Colleagues, please correct me if I'm wrong.

Ashish Acharya · Answer

Quoting this because everyone is mentioned here.

Since Michael objected, I had to throw in some codes. :)

Without going into too much detail on the tax code, we know that

1)  less than 7 days or less and

2) 30 days or less are two of the 6 exceptions to rental activity provided for passive activity purpose. Sec 469.

However, per section 1402,  just because a rental activity is treated as a trade or business for passive activity purposes does not automatically mean it is subject to self-employment taxes. For example, a vacation condo rental that is treated as a trade or business for passive activity purposes solely because the average rental period is seven days or less is still a real estate rental exempt from the self-employment tax.

Per Reg 1.1402(a) - 4(c)(2)- If only services provided in connection with 7 days or less or 30 days or less are beyond customarily provided in connection with the rental of the room or other space the activity produces SE income, if not, NO SE taxes.

The most of the time people tend to provide substantial services when they rent less than 7 days, so income would be subjected to SE income. It was true with normal resorts and hotels before gig economy.

With Airbnb and stuff, people rent the place without substantial services, so the income shouldn't be subject to SE taxes.

As the tax advisor, we tend to advise our a customer that charge separately for cleaning fee and other services.

If structured properly, SE can be avoided.

Let me know if you interpret this differently. This is what I have seen in multiple tax research.

Peter M. · Answer

The agreement between you and the s-corp can be whatever you want, its not like you will sue yourself. How is the income being different each month any different on paper then if you had several tenant vacancies. As long as you are not lying about the income, the IRS won't care that it is not a regular monthly amount. It may look more suspicious if you got audited but as long as it is all above board there's no issue doing that.

Carl Fischer · Answer

@Ellie Narie

Many people lease houses and then use them for Airbnb. I’m sure you and your cpa will arrive at the correct answer by tax time.

I have heard the difference that @Michael Plaks brings out with @Ashish Acharya and @Brian Schmelzlen  and it only convinced me that the tax code needs to be simplified. I don’t know if the trump tax changes will affect it. So get a plan to minimize the taxes and hope it flies. Good luck.

Ellie Narie · Answer

This is what I was thinking as well. However, since airbnb income can be different each month, would it be legal to set up that kind of "rental agreement" with my S-corp in the eyes of the IRS? Where the S-corp only pays me the rent in proportion to what airbnb income the property made that the S-corp was renting out. So it won't be a "monthly" fixed rate, or even a daily fixed rate, it will be different every month. I'm wondering if such an agreement is ok in the eyes of the IRS.

Ellie Narie · Answer

I'm thinking of hosting on airbnb, but I heard that it is self-employment income.

Michael Plaks · Answer

@Ashish Acharya - thank you for providing free research. :)  You win, I lose.

A follow-up though. This situation of a semi-conflict between the two sections kind of forces us to disregard the IRS instructions and report AirBnB on Sch E and not Sch C.

Because you can report non-passive losses on Sch E to be compliant with 469, but you cannot block SE tax on Sch C to be compliant with 1402. It would not be an issue if ran thru a separate company, but most AirBnB operate without such.

Agree? @Brian Schmelzlen?

Michael Plaks · Answer

The agreement can be whatever you want, just like an online advice :)

However, for taxation purposes, this idea of @Carl Fischer will not work without modification. In order to be recognized as a rental activity with operational losses, you will need to rent it to your S-corporation as the fair market value. I cannot argue with a straight face that the market value fluctuates monthly and equates the actual monthly collection.

The overall idea of using an S-corp to control SE tax is valid, but it needs to be implemented differently.

Can you deduct depreciation if your S-corp manages your property?

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