A client formed an LLC between family members for property that is split three ways and that is used by the family members as vacation property. The property is not rented out but used exclusively by each of the 3 family members as a vacation retreat. They filed a Partnership return which showed no income and they deducted the repairs and maintenance as well as the property tax for the property on the return. They issued each of the siblings a K-1 showing these expenses paid and have listed them on line 13 with a code W and line 18 with a code of C. This seems incorrect since this property is not a business and will never show income. My question is should they just file a zero information return each year and deduct the property tax they paid for their portion directly on their Schedule A's? Also, the deduction for the repairs and maintenance should not even be deducted if its not a business. Would that be correct?
You are correct repairs are not deductible. Although 13W with a proper description shouldn't get anyone a deduction. Personally I would use 18C Nondeductible Expenses.
EDIT: It looks like they did use 13W for Real Estate tax and 18C for Nondeductible.
I think once they started on the 1065 filing path they need to continue. A zero return isn't accurate since they did have expenses.
i agree they should just be deductible Sched A deductions for mortgage interest and taxes, an LLC does not make you a business, so the expenses they are deducting through partnership are really passive, and should merely be incorporated into the basis of the property , when and if the property is sold, these expenses will adjust the basis, and they can recover some of these costs as fixing up expenses at time of sale. Dissolve the LLC, and just split it 3 ways on your individual tax returns, less paperwork, less headaches and probably a more accurate way to capture the vacation home expenses, if this turns into a Rental/Vacation Home, then the Partnership makes a little more sense.
This isn’t as awful as it first sounds. I don’t think they’re doing it for tax purposes – it’s estate planning, or litigation avoidance between family members. They can put things in the operating agreement that are difficult to establish elsewhere, and they can more easily trade or gift their interests. There is also the anonymity that comes from not having to disclose initial or subsequent owners, or at least their percentage interests.
It is not correct to say that there will never be any income. When the property is sold, they may be lots of it.
There should be a K-1 explanation that the 13W expense is real estate taxes, to be deducted on Schedule A, subject to the SALT limits. The other expenses are not added to basis. If there are improvements, they should show up in the capital accounts.
You didn’t mention how many siblings are involved here, but if there are more than two or three, I can see where the advantages outweigh the disadvantages. I wonder how the insurance policy is written, though.