Can I deduct from income that I receive as an employee the losses from a rental property or from businesses that I own?

[jmt111]

NJ

Can I deduct from and offset income that I receive as an employee of a company based on any of the following:

• Losses from rental property. I believe the answer to this sub-question is “yes,” provided I am not real estate professional, am actively involved in running the rental properties.
• Losses from a business that I own as a sole proprietor.
• Losses from an LLC that I own as a member, in either of the following frameworks:
  • Merely by the fact that I am a member of an LLC that incurred losses; or
  • By taking a Section 179 Deduction or recovering the cost of an investment in tangible personal property (i.e., gasoline storage tanks).

If the answer to any of the above is “yes, I can deduct the losses from and offset my income,” are there any limitations I should be aware of? For example, I understand that I am not qualified to offset my income by losses incurred in my rental properties if my AGI is $150,000 or more. Are there similar restrictions for taking losses from a business that I own as a sole proprietor or as a member in an LLC?

 

[FlyingRon]

Rental is usually considered a passive activity and hence you can't deduct the losses from that against other active activity income.

Losses from a non-hobby business are deductible, but you need to show that it actually has a business motive.

The LLC depends on the nature of the LLC. If the LLC is a disregarded entity (you're the sole member), then you just treat the profit/loss as if you had incurred it directly. Again, it would depend on the nature of the activity as to if and to what extent that it is deductible. Otherwise, you'll have to explain the nature of the LLC.

179 deductions apply same as anything else. You have to explain the nature of the activity involved.

 

[adjusterjack]

Rental is usually considered a passive activity and hence you can't deduct the losses from that against other active activity income.

Rental real estate is actually one of the potential exceptions to the passive activity rule if certain conditions are met.

Jmt11, See Page E-4.

https://www.irs.gov/pub/irs-pdf/i1040se.pdf

I understand that I am not qualified to offset my income by losses incurred in my rental properties if my AGI is $150,000 or more.

Note that the AGI maximum in 2018 is $100,000 not $150,000.

 

[jmt111]

Regarding the business that I am a sole proprietor in, how can I show that it has a business motive and is not a hobby? It has sustained losses several years in a row, but it is selling some products. However, the costs exceed the income by a couple thousand dollars per year.

My LLC has three members and it owns a gas station that I run. I recently invested a lot of money in gasoline storage tanks, incurring a major loss for the LLC. Can I use that loss to offset the income I receive from my salary?

Note that the AGI maximum in 2018 is $100,000 not $150,000.

I believe the AGI limit is $100,000, but if the AGI is more than $100,000 but less than $150,000, the ability to claim the passive activity loss deduction is still available, but it goes down by $1 for every $2 of income over $100,000. For example, if an individual has a $120,000 AGI, the $25,000 write-off amount is reduced by $10,000, down to $15,000.

 

[Taxing Matters]

Regarding the business that I am a sole proprietor in, how can I show that it has a business motive and is not a hobby? It has sustained losses several years in a row, but it is selling some products. However, the costs exceed the income by a couple thousand dollars per year.

What kind of products are you selling? How long have you been doing this? And if you are losing money year after year, why do you keep doing it? What changes have you made to try to turn the business around and make money? The essential hallmark of a business for tax purposes is that you intend to make a profit from it and operate it in a manner designed to generate a profit. So if you are losing money year after year that will raise suspicion with the IRS that this is not a bona fide business activity but instead a hobby.

My LLC has three members and it owns a gas station that I run. I recently invested a lot of money in gasoline storage tanks, incurring a major loss for the LLC. Can I use that loss to offset the income I receive from my salary?

Your share of the loss from the gas station business would offset other income that you have. But note that the gas storage tanks must be depreciated. You're not going to be able to deduct the full cost of those on your return.

 

[justalayman]

You purchased the gasoline tanks on your own as an individual? Do you use them yourself or do you loan or rent them to the LLC?

Your statement suggests the LLC purchased the tanks rather than you. Otherwise, your purchase would not cause a loss for the LLC. If true, then the expenditure is not your alone but split among the three members.

 

[jmt111]

What kind of products are you selling? How long have you been doing this? And if you are losing money year after year, why do you keep doing it? What changes have you made to try to turn the business around and make money? The essential hallmark of a business for tax purposes is that you intend to make a profit from it and operate it in a manner designed to generate a profit. So if you are losing money year after year that will raise suspicion with the IRS that this is not a bona fide business activity but instead a hobby.

I am selling books. It has been about 6 years. I keep doing it because: (1) I believe in spreading a message through books; and (2) I believe that one day, it is going to be a successful business. It is a very competitive business to be in and it is hard to make money.

Your share of the loss from the gas station business would offset other income that you have. But note that the gas storage tanks must be depreciated. You're not going to be able to deduct the full cost of those on your return.

I read that taxpayers can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year the property was placed in service. This is the Section 179 Deduction, which allows taxpayers to either: (1) elect the Section 179 Deduction; or (2) recover the cost by taking a depreciation deduction.

Am I required to depreciate the gasoline storage tanks? Do I not have the option of taking a Section 179 Deduction?

Am I ineligible for taking a Section 179 Deduction or depreciating the gasoline storage tanks against my other income if my other income is more than $150,000?

How do I depreciate the gasoline storage tanks? Do I take their full value and then divide it by 15 or 25 years and then deduct that amount from my other income?

Does the depreciation act as a deduction on my other income or as a credit?

You purchased the gasoline storage tanks on your own as an individual? Do you use them yourself or do you loan or rent them to the LLC?

Your statement suggests the LLC purchased the tanks rather than you. Otherwise, your purchase would not cause a loss for the LLC. If true, then the expenditure is not your alone but split among the three members.

I own shares in the LLC that owns the gas station and the gasoline storage tanks. I purchased the gasoline storage tanks on behalf of the LLC. The LLC owns the gasoline storage tanks. The LLC’s name is on the invoice, but I funded the purchase.

This LLC is incurring significant losses because of the purchase of the gasoline storage tanks, various construction costs, remediation costs, and so forth. Is there a way to structure the purchases and expenditures such that they can be used to offset my other income?

 

[justalayman]

You keep saying your income when you speak of the tanks. Ift the LLC purchased the tanks, you are only entitled to a pro rata share of the costs compared to your share of ownership of the LLC. The ther two members have the rest of the costs of the tanks as expense of the LlC.

Have you loaned the money to the LLC to purchase the tanks? You aren’t very clear on the mechanics of the situstion. Saying you funded the purchase makes it sound like you have either loaned the money to the LLC or that you purchased the tanks and resold them to the LLC. If the latter, did the LLC pay for them outright or is the LLC making some sort of payments to you?

 

[Taxing Matters]

Am I required to depreciate the gasoline storage tanks? Do I not have the option of taking a Section 179 Deduction?

The LLC operates the service station and is the one that owns the gasoline tanks. The problem is that the LLC cannot take a § 179 deduction for more than the profit that the LLC had during the year. If the LLC lost money even without the tank purchase then the § 179 expense is not an option. The LLC may then only deduct a depreciation expense for the tanks.

All you get to do is take your share of whatever loss the LLC has.

Does the depreciation act as a deduction on my other income or as a credit?

Depreciation is a deduction, not a credit.

I own shares in the LLC that owns the gas station and the gasoline storage tanks. I purchased the gasoline storage tanks on behalf of the LLC. The LLC owns the gasoline storage tanks. The LLC’s name is on the invoice, but I funded the purchase.

Then you made a contribution to the LLC in the amount of what you paid for the tanks. That increases your basis in your LLC interest. It does not give you a deduction. It is the LLC that would either get the § 179 expense deduction or get the depreciation deduction for the tanks.

This LLC is incurring significant losses because of the purchase of the gasoline storage tanks, various construction costs, remediation costs, and so forth. Is there a way to structure the purchases and expenditures such that they can be used to offset my other income?

And those losses are why the LLC is unlikely get any use out of a § 179 deduction and will instead want to depreciate the tanks.

Your share of the losses from the LLC can offest other income but those losses reduce your basis in the LLC. If your basis is reduced to zero then you cannot take further losses from the LLC until you again have basis in the partnership.

The LLC is a partnership for federal tax purposes unless it elected to be classified as a corporation and the rules of partnership taxation are more complex than most people realize. I suggest the LLC have a tax professional familiar with partnership taxation advise it and help it prepare its Form 1065 return and partner K-1s. You may want to consult a tax professional of your own to figure out how the various things you are doing impact your taxes.

 

[jmt111]

You keep saying your income when you speak of the tanks. Ift the LLC purchased the tanks, you are only entitled to a pro rata share of the costs compared to your share of ownership of the LLC. The ther two members have the rest of the costs of the tanks as expense of the LlC.

If the LLC purchased the tanks, can I deduct 50% of the costs of the gasoline storage tanks from my other income, since I own 50% of the shares of the LLC?

If so, how would I do this? Would I claim a loss on Schedule E “Supplemental Income and Loss (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.)”? If so, wouldn’t I be ineligible from taking a deduction on the loss against my other income because my other income exceeds $150,000?

Or would I take the loss on Form 4562 (“Depreciation and Amortization (Including Information on Listed Property)”?

Have you loaned the money to the LLC to purchase the tanks? You aren’t very clear on the mechanics of the situstion. Saying you funded the purchase makes it sound like you have either loaned the money to the LLC or that you purchased the tanks and resold them to the LLC. If the latter, did the LLC pay for them outright or is the LLC making some sort of payments to you?

Not exactly. The LLC did not have enough reserves, so I purchased the tanks using my own money. My attorney says something like I made a “de facto” loan or something like that and that I think we have to document it as such. At the time I was not aware of all the formality and was just rushing to meet regulatory deadlines.

For the purpose of my question, I would just like to understand how I should have structured the purchase so that I can better understand the best way to structure this going forward so that I can (ideally) use the costs incurred in upgrading and remediating the gas station to try to reduce my other income. This gas station has incurred serious losses and I want to see if there are ways to use that to reduce my other income, which exceeds $150,000.

The LLC operates the service station and is the one that owns the gasoline tanks. The problem is that the LLC cannot take a § 179 deduction for more than the profit that the LLC had during the year. If the LLC lost money even without the tank purchase then the § 179 expense is not an option. The LLC may then only deduct a depreciation expense for the tanks.

All you get to do is take your share of whatever loss the LLC has.

The LLC had expenses of almost $300,000 in upgrading and installing the tanks and over $100,000 in remediation-related expenses, for a total of about $400,000, which is far over the income.

Can offset my other income, which exceeds $150,000, by 50% of the losses of the LLC, half of whose shares I own? If so, how do I do this? Via Schedule E for “Supplemental Income and Loss (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.)”?

Then you made a contribution to the LLC in the amount of what you paid for the tanks. That increases your basis in your LLC interest. It does not give you a deduction. It is the LLC that would either get the § 179 expense deduction or get the depreciation deduction for the tanks.

I believe an LLC with more than one member is treated by the IRS as a partnership. The members report the LLC’s supplemental loss or income on their personal tax returns through Schedule E (Form 1040) “Supplemental Income and Loss (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.),” but the LLC itself is not subject to taxation; rather, it is subject to “pass-through taxation.” If that is the case, how does the LLC take a Section 179 Deduction or the depreciation deduction?

Your share of the losses from the LLC can offest other income but those losses reduce your basis in the LLC. If your basis is reduced to zero then you cannot take further losses from the LLC until you again have basis in the partnership.

Can you clarify what this means? Suppose I own 50% of an LLC that experiences $250,000 of losses. If I then file a Schedule E to report $125,000 of losses corresponding to my 50% ownership of the LLC, will my 50% interest in the LLC be diluted?

Also, can I claim the $125,000 in losses to offset my other income, even if my other income exceeds $150,000?

 

[Taxing Matters]

I believe an LLC with more than one member is treated by the IRS as a partnership. The members report the LLC’s supplemental loss or income on their personal tax returns through Schedule E (Form 1040) “Supplemental Income and Loss (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.),” but the LLC itself is not subject to taxation; rather, it is subject to “pass-through taxation.” If that is the case, how does the LLC take a Section 179 Deduction or the depreciation deduction?

The partnership computes its net income or loss on its Form 1065, which looks much like a tax return even though the partnership does not itself pay tax on its income. Most of the ordinary (i.e. non capital) income and deductions of the partnership end up getting lumped together and reported to the partner on the Schedule K-1 line 1 as "ordinary business income (loss)". The LLC thus computes its ordinary business income/loss for the year on Form 1065, including any depreciation expense for the tanks, and that all ends up as a single item of income or loss that gets reported to the partner. As a 50% partner, you'd be allocated half that ordinary business income or loss.

The section 179 expense is treated differently. That expense, if elected by the partnership, does not get deducted by the partnership in computing its ordinary business income or loss. It is instead reported to the partners on line 12 of the K-1 and the partners then report that item separately on their returns. As a 50% partner, you'd be allocated 50% of that § 179 expense.

The LLC had expenses of almost $300,000 in upgrading and installing the tanks and over $100,000 in remediation-related expenses, for a total of about $400,000, which is far over the income.

The § 179 expense has several limitations. One of them is that the deduction cannot exceed the income you had from active trades and businesses. So if the partnership elects to use § 179 for this, you'll get reported your 50% share of that on line 12 of your K-1 and then you must apply the various limits to see how much of that you get to deduct on your return for the year. The unused portion gets carried over to the next year, where you go through the same process of applying the limitations to determine how much you can take business had. So, if the LLC had $50,000 of net income for the year (not counting the section 179 costs) and your share of that is $25,000, and you had other active business income of $15,000 during the year, and the LLC reports your share of a § 179 deduction as $200,000, you won't be able to use all of that $200,000 this year you'd get to use $40,000 of it to offset the business income that you had.

Whether it is better overall for the LLC to elect a section 179 deduction or to depreciate items that are eligible for a section 179 deduction just depends on which one is likely to provide the best benefit over the years involved, which means making some projections of business income into the future.

Can offset my other income, which exceeds $150,000, by 50% of the losses of the LLC, half of whose shares I own?

If the line 1 of the K-1 that has the ordinary income (loss) on it has a loss, that's a net operating loss (NOL) and that can offset other income on your return, including non business income. So if you had income from wages, interest, dividends, pensions, or whatever, that can be offset by the NOL. If the tanks are depreciated by the LLC, that expense will be part of the NOL.

The section 179 expense is not part of the NOL. It is treated differently, as I described above. It can offset business income that you had, but nothing else. So it can't reduce your income from wages, interest, dividends, pensions or any other non business income.

So those considerations help factor into whether the section 179 expense or depreciation is the better way to go.

Can you clarify what this means? Suppose I own 50% of an LLC that experiences $250,000 of losses. If I then file a Schedule E to report $125,000 of losses corresponding to my 50% ownership of the LLC, will my 50% interest in the LLC be diluted?

Your interest is not diluted. Basis is a tax concept that tracks your investment in the partnership. Basis is important because it affects a number of things for the partner.

Let me give you a simple example. Suppose XY partnership organized on 1/1/2018 with two partners, each contributing $50,000 to the partnership to start it up and each being a 50% partner. The $50,000 they each contribute to the partnership gives them each $50,000 in basis in the partnership. During 2018 the business ends up with a $150,000 net loss, which it allocates $75,000 to each partner. When a partnership has a profit, that profit passes through to the partners and increases their basis in their partnership interest. Losses of the partnership also pass through to the partners but reduce the partners basis in their partnership interests, but the basis cannot be reduced below zero. So each partner is allocated $75,000 of the loss but since they each only have $50,000 basis in their partnership interest, they each only get to deduct $50,000 of loss on their 2018 return and their basis in the partnership drops to zero. The unused loss of each partner of $25,000 is trapped and cannot be used by the partners until they have increased their basis in the partnership again, either through additional contributions to the partnership or because the partnership makes money in later years that increases basis. Note that distributions from the partnership also decreases basis, so that must also be taken into account in determining what basis the partner has to absorb the loss.

 

[jmt111]

The partnership computes its net income or loss on its Form 1065, which looks much like a tax return even though the partnership does not itself pay tax on its income. Most of the ordinary (i.e. non capital) income and deductions of the partnership end up getting lumped together and reported to the partner on the Schedule K-1 line 1 as "ordinary business income (loss)". The LLC thus computes its ordinary business income/loss for the year on Form 1065, including any depreciation expense for the tanks, and that all ends up as a single item of income or loss that gets reported to the partner. As a 50% partner, you'd be allocated half that ordinary business income or loss.

The section 179 expense is treated differently. That expense, if elected by the partnership, does not get deducted by the partnership in computing its ordinary business income or loss. It is instead reported to the partners on line 12 of the K-1 and the partners then report that item separately on their returns. As a 50% partner, you'd be allocated 50% of that § 179 expense.

If I understand correctly, an LLC, much like a natural person, can elect to either:

deduct the value of the gasoline tanks in the year they were placed in service by reporting the Section 179 Deduction on line 12 of Schedule K-1, thereby allowing the members to report the Section 179 Deduction on their returns; or

recover the cost of the tanks by taking a depreciation deduction over a set number of years and using the value of the depreciation to offset the business income, allowing the LLC to report a loss on Form 1065, which the members can then use according to their respective allocations to offset their other income.

The § 179 expense has several limitations. One of them is that the deduction cannot exceed the income you had from active trades and businesses. So if the partnership elects to use § 179 for this, you'll get reported your 50% share of that on line 12 of your K-1 and then you must apply the various limits to see how much of that you get to deduct on your return for the year. The unused portion gets carried over to the next year, where you go through the same process of applying the limitations to determine how much you can take business had. So, if the LLC had $50,000 of net income for the year (not counting the section 179 costs) and your share of that is $25,000, and you had other active business income of $15,000 during the year, and the LLC reports your share of a § 179 deduction as $200,000, you won't be able to use all of that $200,000 this year you'd get to use $40,000 of it to offset the business income that you had.

Suppose I had active income of $160,000 and the LLC opts to elect a Section 179 Deduction of $200,000, 50% of which would be allocated to me. Can I offset my $160,000 active income such that I am only taxed on $60,000 of my income? I understand I cannot write off my rental property losses against my other income on Schedule E if my AGI exceeds $150,000. Is there a similar rule that prohibits me from writing off losses from my ownership in an LLC against my other income?

 

[LdiJ]

If I understand correctly, an LLC, much like a natural person, can elect to either:

deduct the value of the gasoline tanks in the year they were placed in service by reporting the Section 179 Deduction on line 12 of Schedule K-1, thereby allowing the members to report the Section 179 Deduction on their returns; or

recover the cost of the tanks by taking a depreciation deduction over a set number of years and using the value of the depreciation to offset the business income, allowing the LLC to report a loss on Form 1065, which the members can then use according to their respective allocations to offset their other income.



Suppose I had active income of $160,000 and the LLC opts to elect a Section 179 Deduction of $200,000, 50% of which would be allocated to me. Can I offset my $160,000 active income such that I am only taxed on $60,000 of my income? I understand I cannot write off my rental property losses against my other income on Schedule E if my AGI exceeds $150,000. Is there a similar rule that prohibits me from writing off losses from my ownership in an LLC against my other income?

Only if that income was active business or trade income. However, the partnership can only make the 179 election if the partnership had sufficient profits to allow the election to be made. If the partnership cannot make the 179 election they cannot pass it on to you.

 

[Taxing Matters]

Only if that income was active business or trade income. However, the partnership can only make the 179 election if the partnership had sufficient profits to allow the election to be made. If the partnership cannot make the 179 election they cannot pass it on to you.

Correct. For the OP's clarification, IRC § 179(d)(8) applies the § 179(b) limitations to both the partnership and the partners, which includes the active trade or business income limitation. So the partnership can only take the § 179 deduction to the extent of its active trade or busines income (not counting the §179 expense deduction) and that deduction is what gets allocated ot the partners. Then the partners are also limited in taking the deduction allocated to them by the amount the active trade or business income they have.

This is why I said earlier in the thread:

The problem is that the LLC cannot take a § 179 deduction for more than the profit that the LLC had during the year. If the LLC lost money even without the tank purchase then the § 179 expense is not an option. The LLC may then only deduct a depreciation expense for the tanks.

If the LLC had a profit (not counting the purchase of the tanks) then whether it is worth using a § 179 expense vs. depreciation will depend on how much profit the LLC had — if it wasn't very large the § 179 deduction may end smaller than what the depreciation expense would be, making depreciation the more attractive option.

The partners are then also limited in how much they can use their share of the § 179 expense that is allocated to them by the partner's active trade or business income (not counting that § 179 expense).

 

[jmt111]

A few times in this thread, I have raised a question as to whether wages that exceed $150,000 can be offset by losses in an LLC in which I am a member, but I do not believe I have received a clear reply. Isn't there a limit that only allows for deductions to offset wages if the wages do not exceed $150,000?

Does it make a difference that the LLC in which I am a shareholder owns a gas station that is rented out to an operator tenant? I am not sure how this plays into LdiJ's comment, "Only if that income was active business or trade income." I actively maintain the property that the LLC owns, and this property is then leased to an operator. Is this "active business or trade"?