Watson CPA Group - Knowledgebase

Knowledgebase

Rental Losses with an S-Corp

Article ID: 188
Last updated: 21 Sep, 2014
Revision: 4
print  Print
share  Share
comment  Add comment
Views: 0
Comments: 0

By Jason Watson ()
Updated September 2, 2014

As mentioned earlier, K-1 income from an S-Corp will be reported on Schedule E of your personal tax return since it is business investment income. If you do not materially participate in the S-Corp’s operations, this can be a huge windfall if you are a rental property owner too. How does this play into S-Corps? Here we go-

Let’s presume that you have a rental loss of $50,000. Rental income is typically considered passive, meaning that you are not directly earning the income as you would with a job. Passive losses may be deducted from non-passive income such as wages, but there are limits. Passive loss limits for married taxpayers max out at $25,000, and that number decreases as your gross income increases.

Specifically, passive loss reduces $1 for every $2 over $100,000 adjusted gross income and by $150,000 (for married filing joint taxpayers) the passive loss deduction is $0. Bummer. Not all is lost however.

Let’s also presume that you are a minority investor in an S-Corp that earned $50,000 and reported the income on a K-1. Let’s say you do NOT materially participate in the running of the S-Corp. Without the rental, you would be taxed on $50,000. Without the S-Corp you would only be able to deduct $25,000 worth of passive losses. But with both the rental and the S-Corp, you shelter $50,000 of your K-1 with your rental losses, and pay $0 tax. Cool, huh?

Granted, this is rare- most S-Corp shareholders actively participate and cannot offset their S-Corp income with rental losses. Although there might be some wiggle room with spouse A owning 90% of an S-Corp, for example, that he or she doesn’t materially participate in. The same spouse A could then own 100% of the rental properties. This can get convoluted for sure, and careful tax planning must be exercised.

As a side note, it is NOT a good idea to make an S-Corp election on your LLC if it owns rental property. Rental property by definition is passive income (unless you are a real estate professional as defined by the IRS) and therefore not subject to self-employment tax. But if you run your rentals through an S-Corp, you will be required to perform payroll and you’ll be paying Social Security and Medicare taxes which are the same as self-employment tax. Don’t do it. You’ll artificially increase your tax liability by essentially converting passive / unearned income into earned income.

Taxpayer's Comprehensive Guide to LLCs and S Corps
This KB article is an excerpt from our book which is available in paperback from Amazon, as a free PDF from us, and as an eBook for Kindle, Apple iBook, Barnes and Noble Nook, among others. You can cruise through these KB articles, click on the fancy buttons below or visit our webpage which provides more information at-

www.watsoncpagroup.com/book

This article was:   Helpful | Not helpful Report an issue


Prev     Next
Rentals Owned by an LLC Fallacy       Audit Rates and Risks with an S-Corp