Self employment tax with property in LLC

[Maximilian Benjamin]

Sorry for the long post but I thought this was an interesting email conversation...

...which ensued when I began discussing with my CPA about future expansion and what I ultimately want to do with regards to real estate.

Currently I have one property purchased under an LLC (single member-me with me as guarantor). I am in the process of purchasing two additional properties in two weeks (pain), each will be in its own individual LLC. The discussion basically dealt with me thinking about someday forming a holding company LLC that would only hold assets and not hold property, nor would it be responsible for managing the properties. I would like a "brand" per se, a company that could diversify and purchase/own/form not only LLCs "holding" property, but also other types of non-similar businesses (the sky is the limit!) I've talked with my lawyer about this and he suggested I also discuss this with my accountant to determine the best method to orchestrate this from a tax perspective.

My accountant suggested that the properties held individually in LLCs elect to be taxed as an S corp, because of possible self employment tax, to which I replied "Isn't rental income (passive income since I'm not a real estate dealer) excluded from the self employment tax? Also, couldn't the holding company be an LLC as a disregarded entity?..." (to avoid SE). "The second I could see would be a problem if the holding company owned business that were not passive income streams."

His response:

"My preference would be to treat each as its own S-Corporation. If these are taxed as Schedule C Disregarded Entities, self-employment taxes come into play in years that the rental is profitable. We can avoid some of this as an S-Corp. This will still be considered a passive activity under either method, so based on your modified adjusted gross income the deducibility of losses will be limited."

Additional clarification:

"Ordinarily, you are correct. Rental real estate reported on schedule E is not SE income. However, the guidance I am getting from the IRS on this issue is that when the real estate is held by an LLC, that makes it a business reported on schedule C as a sole proprietorship, which brings SE issues into play. My initial thought mirrored yours, but that is not the answer I got when I spoke with the tax research folks at the IRS.

For the second issue, the primary concern is how the income gets reported. If I understand the scenario, the holding company is only going to hold the assets, thus has no income. The individual units would report the income from operations. We can disregard all entities and reports each on it’s own schedule C without any problem, or each entity can elect to be treated an its own S Corporation. What we can’t do is report the income from each separate LLC on the same S Corp return as the holding company, because, in the view of the IRS, this represents a consolidated tax return and S Corps are precluded from filing consolidated returns."

I didn't have a chance to talk to him personally today but we will be discussing this on Monday. I know a number of individuals here who own multiple properties in LLC's file a consolidated tax form using schedule C, so I am curious as to what the community thinks, particularly regarding the SE issue.

Whew! Again sorry...