Passive Income Exception for Schedule E, is it even discussed?

[Josiah B.]

Hello

Lots of people have their opinions about asset protection and what is best but their is a line in the IRS Schedule E form instructions that concern me about using the Land Trust/LLC asset protection strategy. Let me explain.

A popular strategy is to hold your property in a land trust (title) and then use a LLC (Wyoming LLC) as the trustee and then another Wyoming LLC as the beneficiary, both of which the investor owns. This sounds like a solid plan and have seen many people implement it but there is a section in the IRS Schedule E instructions that seems to possibly throw a wrench in it?

Under the “Passive Activity Loss Rules” there is an exception most small investors can take that allows the loss in their real estate can go against wages, etc called the “Exception for Certain Real Estate Activities.” Most small self managed investors can achieve the conditions (see below):

1. “Rental real estate activities are your only passive activities.
2. You do not have any prior year unallowed losses from any passive activities.
3. All of the following apply if you have an overall net loss from these activities:
   1. You actively participated (defined later) in all of the rental real estate activities;
   2. If married filing separately, you lived apart from your spouse all year;
   3. Your overall net loss from these activities is $25,000 or less ($12,500 or less if married filing separately);
   4. You have no current or prior year unallowed credits from passive activities;
   5. Your modified adjusted gross income (defined later) is $100,000 or less ($50,000 or less if married filing separately); and
   6. You do not hold any interest in a rental real estate activity as a limited partner or as a beneficiary of an estate or a trust.”

My question revolves around part f above. If you implement the asset protection strategy as described above, would you still qualify for this passive loss exemption due to condition f? Because you would technically hold a interest in an trust through your LLC. What if you had a property just in a trust and you were directly the beneficiary, then would you be disqualified for the passive exemption? I am really interested to see if anyone has any experience with this or another IRS rule that overrides this point?

Disclaimer. This is for educational purposes only, not legal, accounting, investing, or any type of professional advice.

Thank You, Josiah