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Commercial Rental without Rent

Technical topics regarding tax preparation.
#1
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During 2019, a group of individuals acquired a nonresidential building. This building is two story. The top floor is a short-term rental (e.g. AirBnB) and the bottom floor is a commercial restaurant.

The individuals acquired the building (with land) through LLC A, which is taxed as a partnership. They also acquired the assets of the restaurant business through LLC B, also taxed as a partnership.

The top floor was rented during the entire period of ownership during the year and made quite a bit of money. The bottom floor was in use from the purchase date through end of year by the restaurant business "tenant" -- LLC B.

The problem, no rent was paid from LLC B to LLC A for the use of the bottom floor, and there is no rental contract in place.

The reason: "not enough money".

Is the allocable portion of building related to the bottom floor even in service? Or is this a not for profit rental?
 

#2
Nilodop  
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So it's a brother/sister partnership arrangement, right? Two LLCs, each with same members and each treated as partnerships.

I'd wonder about sharing of income and loss in each entity, and whether there are any GPs.

I'd wonder whether they are both cash method.

I'd become familiar with section 267 if they are not both cash method.

I'd also learn a bit about section 482.

I'd wonder if and when they expect to have one pay the other the rent, and I'd have them get a lease in place.

I'd think the income and expense wash, except I'd wonder about passive v active as to each member of each LLC.

I'd certainly look into the SE tax aspects if one LLC has a loss and one has income.

I'd probably also wonder about their investments in each LLC and whether there is some debt.

Then I'd advise them what to do.

I forgot - I'd also hope they are keeping cash accounts separated between the two, and putting income and expenses in the right one.
 

#3
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Looks like I have my reading for tonight. Thank you for your response.

Yes, approximately brother-sister. The restaurant manager has a small profit and loss interest in LLC B that it doesn't have in LLC A, but that is the only difference. They are both accrual under IRC Sec 448(a)(3). Separate checking accounts are maintained.

The individuals of LLC A are the functional equivalent of limited partners in LLC B. The only member of LLC B that has SE tax exposure is the manager.

I'm going to include a self-rental footnote when applicable. Some of the members are my clients, but some are not.

That you for straightening me out on the other thread regarding statute of limitations for examination as well. I come here to learn and am never disappointed.
 

#4
Nilodop  
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They are both accrual under IRC Sec 448(a)(3).. I confess that surprised me.
 

#5
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Yes. Both have losses for 2019 and are therefore Sec 1256(e)(3)(B) syndicates.

LLC A is owned by 5 members. One is a partnership, Four are individuals or DEs owned by individuals. LLC B is owned by 6 members. The same five members from LLC A plus the manager, which is organized as a DE owned by an individual.

For each LLC: no member is related to any other member, no single member owns more than 50% of the profit, loss, or capital of the LLC.
 

#6
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So from what I gather...

Sec 267(a)(2) functions to expressly prevent manipulating method of accounting timing differences between related parties. e.g. what it seeks to prevent is: Taxpayer A, who is accrual basis, accrues an expense to related Taxpayer B who, as cash basis, doesn't recognize that income until the next tax year.

I don't think this paragraph applies to my fact pattern. Both LLC A and LLC B are accrual. And, there is no agreement between the LLCs. The "effective" agreement between the LLCs (which is in reality just whatever the head honcho of these LLCs decides) seems to be rather nonchalant and is something along the lines of: LLC B doesn't have much money, so we're not going to think about any kind of agreement yet or make payments. LLC A is fine because the top floor is bringing in tons of cash via the short-term rental. We have time to figure this out.

I know this needs to change as soon as possible, and a bona fide lease contract with (approximately) fair market rents needs to be put into place.

Sec 482 seeks to prevent income or loss shifting that may happen when two related taxpayers interact. Treas. Reg. Sec 1.482-1(a)(3) allows a controlled taxpayer to, if necessary to reflect an arm's length result...report on a timely filed U.S. income tax return (including extensions) the results of its controlled transactions based upon prices different from those actually charged. [Emphasis Added]

Treas. Reg. Sec 1.482-2(c)(1) mentions that when tangible property is leased from one member of a controlled group to another without charge the district director may make appropriate allocations to reflect an arms-length charge.

What I'm taking away here is that I should put the building into service and accrue rents back and forth between the two LLCs under Sec 482? Does this seem correct? Accounts receivable and payable build up until they can eventually be paid? This doesn't seem to run afoul of Sec 267.

Nilo...you asked about debt basis. All the members of LLC A have personally guaranteed the mortgage of LLC A. All of the members of LLC B, except the managing member, have personally guaranteed the mortgage used to purchase the restaurant assets acquired by LLC B.

No SE tax exposure on LLC A. The only member that has SE tax exposure on LLC B is the manager. All the other members are the functional equivalent of LPs.

All interests will be passive, except for the manager's interest in LLC B. I expect him to meet material participation there, although he is not a client.
 

#7
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Any ideas on this guys?

Thanks for any help.
 


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