How to Do Real Estate Partnership without 1065

Question

I've read that you can file real estate partnerships without actually filing a 1065.

"The IRS and the courts have stated that mere co-ownership, rental, and maintenance of real property does not create a partnership for federal income tax purposes. Similarly, mere agreements to share expenses do not create partnerships for federal income tax purposes."

How would me and my partner file taxes for 2021 if one person is on the loan, but both are on title?

1. Do we split the one 1098 form on our own Schedule Es even though one person is on the loan?

2. Is this something that can be done on Turbotax?

Thanks in advance

Michael Plaks · Answer

Your understanding may or may not be correct. It depends on the details of your arrangement, and nobody can give you a Yes/No without a deeper discussion. And even then, the answer will come with an asterisk, as in "most likely, you can (or cannot)."

This is because we do NOT have a clear answer in the tax law. Instead, we have a pile of confusing information like you see in an earlier response by my colleague. It's hard to understand even for us tax professionals and next to impossible for everybody else.

I will try to give some layman's introduction that will intentionally avoid most technical terms and use simpler words. But when I do that, my answer loses technical accuracy and nuances, which is risky. So, here we go...

1. Two people doing business together is normally a partnership. You do not have to formally structure it as a partnership or form some business entity like an LLC. You do not have to have things in writing. If you do business together, then it's typically a partnership.

2. But what does it mean "doing business together"? Specifically, what is a "business" and what is "together"? This is where we start having problems. These terms are rather loosely defined in the law. It leaves a lot of room for interpretation. You know what it's similar to? Defining when you are in a relationship.

• If you got married, then it's pretty obvious you are in a relationship. In business, it's equivalent to creating an LLC. If you created one and operate under the LLC name - definitely a partnership.
• If you're Facebook official, then we're also supposed to believe your relationship status. In business, it means telling people (sellers, lenders, tenants, etc.) that you have a "business partner." Then you conceded having a partnership.
• But what if you keep it more casual and less committed? Do you or do you not have a relationship/partnership? It depends, right? You may think that you do not, and your girlfriend may very well think differently. Try using your phrase on her: "my understanding..." and let's see if you can finish it ;)

3. If this was not messy enough, there're two situations that sound similar but are actually distinct in the law. One is where you do not even have a partnership to begin with, and the other is when you do have it but elect to treat it as if you don't.

4. In case of partnerships, it's the IRS who decides yes or no, not you and not even us tax professionals. If we disagree with the IRS, it sometimes goes to court. Would've been nice if the courts declared some simple rules. They don't. They say yes in some cases and no in others. Then we're trying to compare our situations to those addressed by the courts and guess which case is most similar to ours. But it's only a guess.

5. Over the years, actually decades, of this ongoing controversy some rules of thumb developed. They are not hard rules, however, and there have been exceptions. Fun, I know. Here are these commonly accepted dos and don'ts:

• Do own property legally as "tenants-in-common." Check with an attorney how you own your property, because the rules are complicated and change from state to state.
• Do share all expenses and all income evenly.
• Do not create an LLC.
• Do not tell people you are business partners.
• Do preserve each other's right to act independently, including selling your respective interests. This one is tricky and needs to be discussed with a tax professional.
• Do not do anything together beyond what is normal for landlords.

Clear as mud, I know.

6. Assuming that you do conclude that there is NO partnership - how do you report this joint ownership? Half of everything on each return: half of rent income, half of all expenses, half of depreciation, half of the gain when sold.

The best thing to do with your 1098 is to issue a "nominee 1098" for half of the interest from you to your partner. Google it or get help. The second option is less hassle but is not by the book and has more risk: report half of your 1098 as "mortgage interest" and have him report his half as "other interest."

7. Think ahead about all potential problems down the road and figure out how you will handle them if they happen. It's too late to discuss when the problem is already in your living room. What if one of you wants out? What if one of you gets into health or financial or family troubles? What if you have tenant issues? Maintenance issues? Legal issues?

Remember: this thing is similar to being in a relationship. Always sweet at the beginning but does not always stay this way. Good luck.

David Y M. · Answer

@Ashish Acharya so do we just split the mortgage form even though it’s under my SSN? How do we split the 1098. My understanding that it is okay to file on our own Schedule E

Ashish Acharya · Answer

Rev. Proc. 2002-22: IRS has rules.

These factors, which should continue to apply to the separate entity test under the check-the-box regulations, include—

• the sharing of profit from the business;
• the sharing of losses from the business;
• ownership of a capital interest or performance of substantial services;
• participation in management; and
• representation to third parties as a partnership (including the filing of partnership returns, the existence of a partnership agreement). See generally Luna, Hubert M., (1964) 42 TC 1067.

The Supreme Court has explained that the distinction between co-owners of property and partners depends on whether they intend to and, in fact, join together for the present conduct of an undertaking or enterprise-

The following factors are often cited as evidence of this intent:

• The agreement of the parties and their conduct in executing its terms;
• The contributions, if any, that each party makes to the venture;
• Control over income and capital and the right of each party to make withdrawals;
• Whether the parties are co-proprietors who share in net profits and have an obligation to share losses;
• Whether business was conducted in the joint names of the parties;
• Whether the parties held themselves out as joint venturers; and
• Whether separate books of account were maintained for the venture.

The court held that the co-ownership arrangement constituted a partnership for federal tax purposes. Among the factors that influenced the court's decision were the limitations on the co-owners' ability to sell, lease, or encumber either the co-ownership interest or the underlying property, and the manager's effective participation in both profits (through the remarketing fee) and losses (through the advances). BergfordUnder § 1.761-1(a) and  §§ 301.7701-1 through 301.7701-3, a federal tax partnership does not include mere co-ownership of property where the owners' activities are limited to keeping the property maintained, in repair, rented or leased. However, as the above authorities demonstrate, a partnership for federal tax purposes is broader in scope than the common law meaning of partnership and may include groups not classified by state law as partnerships. Bergford, 12 F.3d at 169. Where the parties to a venture join together capital or services with the intent of conducting a business or enterprise and of sharing the profits and losses from the venture, a partnership (or other business entity) is created. Bussing, 88 T.C. at 460. Furthermore, where the economic benefits to the individual participants are not derivative of their co-ownership, but rather come from their joint relationship toward a common goal, the co-ownership arrangement will be characterized as a partnership (or other business entity) for federal tax purposes. Bergford, 12 F.3d at 169.

This should be satisfied: (Main Points)

• The co-ownership may not file a partnership or corporate tax return, conduct business under a common name, execute an agreement identifying any or all of the co-owners as partners, shareholders, or members of a business entity, or otherwise hold itself out as a partnership or other form of business entity (nor may the co-owners hold themselves out as partners, shareholders, or members of a business entity). The Service generally will not issue a ruling under this revenue procedure if the co-owners held interests in the Property through a partnership or corporation immediately prior to the formation of the co-ownership.
• 
• Each co-owner must share in all revenues generated by the Property and all costs associated with the Property in proportion to the co-owner's undivided interest in the Property. Neither the other co-owners, nor the sponsor, nor the manager may advance funds to a co-owner to meet expenses associated with the co-ownership interest unless the advance is recourse to the co-owner (and, where the co-owner is a disregarded entity, the owner of the co-owner) and is not for a period exceeding 31 days.
• 
• The co-owners must share in any indebtedness secured by a blanket lien in proportion to their undivided interests.

Distinguishing a Partnership From Co-Owners of Leased Property

In the case of property to be purchased by more than one equity investor and subjected to a long-term triple net lease, it may be possible for each equity investor to structure its participation as a purchase and lease of an undivided interest in the property, separate from the other equity investor's transaction, so as to preserve arguments that the equity investors are mere co-owners. Thus, purchase prices, rent schedules, debt schedules, renewal and purchase options and other terms of the transactions can be different for different investors. See Rev. Rul. 82-61, 1982-1 C.B. 13 ( in the ruling, In addition, the participants in the organization must own the property as coowners, either in fee or under lease or other form of contract granting exclusive operating rights, and the participants must reserve the right separately to take the property produced in kind or dispose of their shares but may not jointly sell the property produced. The participants in the organization must also be able to compute their own income without having to compute partnership taxable income.); Rev. Rul. 75-374, 1975-2 C.B. 261 . (Rev. Rul. 75-374, 1975-2 C.B. 261, concludes that a two-person co-ownership of an apartment building that was rented to tenants did not constitute a partnership for federal tax purposes. In the revenue ruling, the co-owners employed an agent to manage the apartments on their behalf; the agent collected rents, paid property taxes, insurance premiums, repair and maintenance expenses, and provided the tenants with customary services, such as heat, air conditioning, trash removal, unattended parking, and maintenance of public areas. The ruling concludes that the agent's activities in providing customary services to the tenants, although imputed to the co-owners, were not sufficiently extensive to cause the co-ownership to be characterized as a partnership. ) These arguments lose some strength, however, where it is clear that the investors have jointly negotiated the terms of the transactions and would be unable to separately use their interests in the property without significant cooperation and joint efforts among the co-owners. See Rev. Rul. 68-344, 1968-1 C.B. 569 .

Certain types of property may more easily be leased in an undivided interest structure, if they permit the co-owners to continue to receive the benefits of owning their undivided interest after the lease expires without the degree and type of cooperation with their co-owners that would cause them to be partners. It may also be possible for co-owners of certain types of property to elect to be excluded from the partnership provisions of the Code pursuant to Code Sec. 761 .

The IRS has issued guidance on when it will rule that the ownership of undivided interests in rental real property does not result in an entity. See Rev. Proc. 2002-22, 2002-1 C.B. 733 .