Business Retirement plans and deductions

[James H.]

Hello. My fiance has a house in her name that she would like to rent out in the near future. I've read about transferring to an LLC but most of the conversations deal with liability and not tax, which is my primary concern in asking this question. If she keeps the house in her name and doesn't have a business entity owning the property, are any tax deductions or business benefits not available therefore? For instance, improving your live-in home, if I understand correctly, ads to the cost basis of the property but isn't a deduction. However, it would be a deduction for a rental property owned by a business. But since the house is still in her name, is there any issue with declaring that the improvements are business related? We've made improvements to the house since we lived here as private residents, so would any of those count as business deductions retroactively? In general, are any tax benefits lost if a property is in her name personally?

Separately, does rental income count as a type of income that can be used for SEP IRA or Individual 401K retirement plan contributions?

And final question, since I am also a contractor on the side, if I do any improvements to the property should I not be paid or should I take a reported income. Just thinking through the best approach from a tax perspective for both her and I.

Thanks

[Michael Plaks]

@James H.

1. Whether she owns a rental house in her own name or in an LLC changes absolutely nothing for taxes. As you already know, it potentially affects your legal protection, but it makes no difference for taxes. Whatever is deductible can be deducted with or without an LLC. Whatever was not deductible without an LLC is still not deductible with an LLC. Nothing lost and nothing gained.

2. Improvements you made to the house while living there are most likely not deductible, because they benefited you personally. If they were specifically done in preparation for renting the property, they might be partially deductible, but it needs to be analyzed case-by-case. However, your house is not yet available for renting, it is merely your plan for the future, so the answer is almost certainly no. 

The only good news is that these improvements will slightly increase depreciation deduction once you start renting, and they will also reduce the capital gain when you eventually sell the house.

3. Rental income cannot be used to fund any retirement plans. Your contractor's income can.

4. Being compensated for your work is between you two. Did you do her a favor not expecting any money - or did she hire you with an expectation of being paid? If you were actually paid for the work, it is potentially a business deduction for her and certainly taxable income to you. Since her property is not yet a rental property, she cannot really deduct payments to you anyway. Your income however is always taxable.