Taxes, Multi-Family Live-In, and LLC???

[Luke Johnson]

My wife and I bought our first property in June of 2021. We are househacking a triplex where we rent two units out and live in the 3rd unit while renovating. We are now looking to move on to our next property. 

A family member saw our success with the first property and wants to get into real estate with us under a LLC. He is attracted to the tax benefits of operating out of an LLC to offset a high W2 income. He also wants the liability coverage of an LLC instead of an umbrella policy. The basics of how we would operate our next property would be, he provides the capital for the down payment and we put in the sweat equity and maintenance. What I am curious about is what can be claimed when we go to do taxes if we purchase under an LLC and live in one of the units. I believe we could only claim the portion that we aren't living in but could the other member claim the whole property?

I'm also curious about the best type of financing for something along these lines? 
  

[Tim Bee]

Texas has pretty high property taxes compared with many other states.

[Chris Picciurro]

Interesting situation - just consider that an LLC doesn't provide additional tax deductions in this case. Ordinary and necessary expenses are deductible. The LLC provides asset protection (still valuable). You also have to consider property taxes on a non-homesteaded property. If you reside in one of the units (house hack) then 2/3 of the property would be consider a rental property business. That activity will be reported on your personal return or, if a multi-member LLC if formed, a partnership return - Form 1065. Maybe your family member would consider being a lender and you own the property.....

[Luke Johnson]

Quote from @Chris Picciurro:

Interesting situation - just consider that an LLC doesn't provide additional tax deductions in this case. Ordinary and necessary expenses are deductible. The LLC provides asset protection (still valuable). You also have to consider property taxes on a non-homesteaded property. If you reside in one of the units (house hack) then 2/3 of the property would be consider a rental property business. That activity will be reported on your personal return or, if a multi-member LLC if formed, a partnership return - Form 1065. Maybe your family member would consider being a lender and you own the property.....

Thanks for the info Chris. We thought about that route for our first property but things got confusing with gift letters verses being a lender. In the end we decided to just purchase the property on our own with a 3.5% down FHA loan. I'm curious, what benefits would he have by being a lender (I'm assuming you mean lending the down payment amount) instead of buying a property in a multi-member LLC?  

[Lawrence Potts]

@Luke Johnson, really interesting situation…

I don't think a lender would lend on an LLC with one of the members living in one of the units unfortunately. I could be wrong, but if it's under an LLC with partners, they're going to treat this as a non-owner occupied investment property? If I'm understanding the situation correctly.

If your partner was a private lender, he’d be taxed differently on the return of his initial investment. I’m not a tax expert, but the income would be considered passive rather than active and I believe that the interest gained is in a lesser tax bracket.

If you guys are going the FHA route and he's wanting to lend you the down payment, underwriters will question this. They will want an LOE (letter of explanation) and that it's a gift with nothing in return. And I highly encourage you guys to not commit mortgage fraud.

Maybe he can provide the funds for the rehab and get a return from there? Hard part is owner-occupied factor.

In regards to taxes….as a partnered LLC and someone owner occupying it, I would highly encourage to talk to a CPA. It all depends on who's on deed and how it's used. There may be a situation where only the percentage of the property that is leased can be depreciated? But as partners in a multi-owned LLC, they're not pass through entities, so it doesn't affect your personal taxes (you'd be filing two separate taxes, one for you, one for the partner LLC). It also depends on the operating agreement and who gets what. Again, talk to your CPA and your attorney to see if this route makes sense to you and your partner and your goals.

[Luke Johnson]

@Lawrence Potts Thanks for all that great info. Unfortunately that is exactly what I was finding when we went to do this the first time and why we switched to purchasing on our own. Spending more time to prep before this next purchase I wanted to put his question out for this exact reason. At this point an LLC doesn't seem to be the tool to get both parties what they are looking for in our real estate investing. We will likely be back to my wife and I pursuing our next purchase on our own. I really appreciate all the information. Thank you!

[Lawrence Potts]

Quote from @Luke Johnson:

@Lawrence Potts Thanks for all that great info. Unfortunately that is exactly what I was finding when we went to do this the first time and why we switched to purchasing on our own. Spending more time to prep before this next purchase I wanted to put his question out for this exact reason. At this point an LLC doesn't seem to be the tool to get both parties what they are looking for in our real estate investing. We will likely be back to my wife and I pursuing our next purchase on our own. I really appreciate all the information. Thank you!

Absolutely! And maybe it’ll make more sense on another deal in the future. I would keep them in the loop and still see how they can get a deal done for them even without you involved in the deal, no benefit or gain to you. And you keep doing you with your house hacks and gain as many properties as you can.

[Chris Picciurro]

The person lending doesn't really obtain tax benefits. The interest you pay would be income to the lender. One idea is for the family member to use a self-directed retirement account to lend so they defer the tax on interest earned. There are rules for some family members in this situation that a SDIRA person can answer. I am just giving you thoughts from the CPA/tax side.

[Corby Goade]

Hey @Luke Johnson- congrats on your house hack! Sounds like a great start to a very promising portfolio for you and your wife. I honestly wish I would have started that same way, so you are ahead of the game. 

As others have mentioned, there are no tax benefits to an LLC, those are more about limiting your liability and there are LOTS of moving parts in setting up an LLC and operating agreemnt. No matter how you do it, there will be different benefits and different risks, and generally speaking, those won't effect your taxes.

I'm down in Boise and do quite a few house hacks similar to yours with clients- I'd be happy to chat and give you some direction and walk through some different strategies and the pros and cons of each if you'd like. Feel free to shoot me a DM.

Best of luck!

[Grant Schroeder]

Thanks for sharing @Luke Johnson! What is your goal for your next purchase - house hack another multi unit or SFR + ADU potentially?

[Basit Siddiqi]

Quote from @Luke Johnson:

He is attracted to the tax benefits of operating out of an LLC to offset a high W2 income.

He should have a conversation with his tax accountant whether this would be possible if he is only providing the capital as he may potentially not have active or material participation.