P/S for land held as investment

[incognito100]

A brother, brother and sister own a farm property with a cabin on it. They started an LLC in 2020 but haven't transferred the land and cabin over to the LLC yet.

The LLC was formed essentially only for liability purposes. There is some timber that can be harvested down the road, but nothing significant. To help cover the taxes and utilities for the cabin we charge family members $5/night to offset some of the bills.

Is the money paid to cover utility costs considered revenue? Or would you be able to call it contributions instead of income (guessing not since other family members (non-owners) pay it also).

My next concern is can you deduct the utilities if you aren't charging fair rent rates? The utilities and taxes total around $3,000 a year. Could you have the utilities be distributions instead of deducting them and showing a loss? Or break even and show the rest as nondeductible expenses?

The "utility" income will total probably $700-1,000 a year, and a farmer pays $350 a year for the right to farm a small field. So all in you're looking at a $2,000 loss.

Would it be better to capitalize the R/E taxes and improvements to add to the basis in the land instead of deducting them?

 

[Just Blue]

A brother, brother and sister own a farm property with a cabin on it. They started an LLC in 2020 but haven't transferred the land and cabin over to the LLC yet.

The LLC was formed essentially only for liability purposes. There is some timber that can be harvested down the road, but nothing significant. To help cover the taxes and utilities for the cabin we charge family members $5/night to offset some of the bills.

Is the money paid to cover utility costs considered revenue? Or would you be able to call it contributions instead of income (guessing not since other family members (non-owners) pay it also).

My next concern is can you deduct the utilities if you aren't charging fair rent rates? The utilities and taxes total around $3,000 a year. Could you have the utilities be distributions instead of deducting them and showing a loss? Or break even and show the rest as nondeductible expenses?

The "utility" income will total probably $700-1,000 a year, and a farmer pays $350 a year for the right to farm a small field. So all in you're looking at a $2,000 loss.

Would it be better to capitalize the R/E taxes and improvements to add to the basis in the land instead of deducting them?

What state?

 

[incognito100]

Pennsylvania

 

[adjusterjack]

Stick around. We have a tax attorney who participates here and will give you chapter and verse about you situation.

 

[Just Blue]

@Taxing Matters

 

[Taxing Matters]

A brother, brother and sister own a farm property with a cabin on it. They started an LLC in 2020 but haven't transferred the land and cabin over to the LLC yet.

The LLC was formed essentially only for liability purposes.

What liabilities are you trying to protect against? It doesn't sound like you three plan to run it as an active business, either as a farm or as rental. You should understand that a LLC does not provide complete liability protection for the owners. Significantly, it does not protect the owners against liability for their own negligence. So let's suppose that Amy, Bill, and Chuck own the LLC. Chuck is negligent in repairing the cabin and as result someone gets injured. The LLC won't protect Chuck from the liability that resulted from his own negligence. The LLC is also likely to be liable for that as well. The LLC would generally protect the other two members from personal liability for that, however. But given that Chuck ends up liable here, and the other members would be liable for their negligence, it is a good idea to have sufficient liability insurance to cover it anyway.

To help cover the taxes and utilities for the cabin we charge family members $5/night to offset some of the bills....Is the money paid to cover utility costs considered revenue?

Yes.

My next concern is can you deduct the utilities if you aren't charging fair rent rates?

Yes, but since it appears that you are not operating this LLC as either an active trade or business or a rental your deductions would be limited to the amount of income you have. In other words, the owners would not get a deductible loss out of this arrangement. While not something you would think of as a traditional "hobby" the hobby loss rules would apply here.

Could you have the utilities be distributions instead of deducting them and showing a loss?

Distributions are money or property that a partnership or corporation pays out to its owners with respect to their ownership interests. Distributions are usually used to pay out profit to the owners. The LLC (which because it has more than one member would be classified as a partnership unless you elected for it to be classified as a corporation instead) paying utility expenses on a property it owns is not a distribution to the members.

Would it be better to capitalize the R/E taxes and improvements to add to the basis in the land instead of deducting them?

You don't get a choice here. The real estate taxes are a deduction you take in the year that they are incurred. They are not an addition to basis. However, improvements (but not regular repairs and maintenance costs) are capital expenses and are added to the basis of the property.

 

[incognito100]

Thanks! @Taxing Matters

What liabilities are you trying to protect against? It doesn't sound like you three plan to run it as an active business, either as a farm or as rental. You should understand that a LLC does not provide complete liability protection for the owners.

We were given advice that in the event one of the three owners would need to go in a nursing home, the nursing home won't go after the property if in an LLC. Or at least they wouldn't win if they did.

You don't get a choice here. The real estate taxes are a deduction you take in the year that they are incurred.

I was thinking if it was land held as an investment you could make an election to capitalize R/E taxes, interest and repairs. But maybe because there is the income of $5/night, that would throw this out and not make it land held for investment? Google search says code section 266.

 

[davew9128]

You don't get a choice here. The real estate taxes are a deduction you take in the year that they are incurred. They are not an addition to basis. However, improvements (but not regular repairs and maintenance costs) are capital expenses and are added to the basis of the property.

I disagree. I'd say its pretty clear the OP is referring to the election under 266 to capitalize costs on unproductive property. That being said, collecting rent (even if well below market) could make this property in service.

It would also be helpful to know what state this is in, because there are state/local property tax laws that apply differently based on being held in an LLC vs personally, particularly with regards to re-assessment when change of ownership takes place between related parties.

All told, the entire thing stinks of "an attorney told me to do this" which is something I see as a tax professional all the time.

 

[Taxing Matters]

I disagree. I'd say its pretty clear the OP is referring to the election under 266 to capitalize costs on unproductive property. That being said, collecting rent (even if well below market) could make this property in service.

I agree that he is indeed referring to that section, but as you note the issue is whether the property is unproductive, and considering the various rents (even though below market) that are being collected I cannot say that the property is unproductive, though I note that neither Treasury regulations nor case law for § 266 have defined the line between productive and unproductive property.

All told, the entire thing stinks of "an attorney told me to do this" which is something I see as a tax professional all the time.

There might well be good legal reasons for using the LLC, but it's not always the best choice, which is why I was probing to find out what exactly the OP was concerned about with regards to liability. If it were a more active rental or trade or business activity it would be pretty easy to say that some form of limited liability entity is a good idea, and that's the outlook of many business attorneys.

Unfortunately many attorneys do not know the tax law well, which is why I advise people getting into business or investments like this consult both a business attorney AND a tax attorney or other tax professional or find an attorney like me that is knowledgeable in both business law and tax law. I tell my lawyer colleagues that do not practice in tax to refer their clients to a tax professional in any case that involves money/property because where money and property are involved there are also generally tax consequences to consider and those tax consequence may affect the decisions that the client makes. I wish I could say that the bar enthusiastically embraces that idea, but I don't see a lot of lawyers making those referrals, certainly not at the rate they should.