Published:
March 23, 2022

Co-ownership tax benefits

Fast-rising home prices and living costs along with mounds of student debt are making it hard for individuals to buy homes on their own. Instead of renting forever, groups of relatives and friends are teaming up to co-buy real estate to gain equity and a second income stream.

But buying a property with friends isn’t as easy as splitting an Uber fare or a pizza. Hence, one of the most frequently asked questions we hear is how to legally establish the co-buy to receive the most tax benefits. Most co-buyers are benefiting from forming a business entity that owns the assets–either a corporation or LLC with the latter being the most popular.

Forming an LLC or a corporation would provide the following benefits:

  • Shield personal assets, including any other properties you may own
  • Increase your tax benefits

What is an LLC?

According to the IRS, an LLC – or Limited Liability Company – is a business structure allowed by state statute. Individual states may use different regulations. Each owner of an LLC is called a member. Most states permit “single-member” LLCs, and on the other side of the spectrum, there is no maximum number of members.

You’ll have to pay state fees to form the LLC and often to maintain it, but the cost of establishing the LLC, including the fees/taxes, are also expenses that can be written off and offset taxes.

How does an LLC impact your taxes?

By default, all LLCs are pass-through entities, unless the owners of the LLC file paperwork to change the company's tax status. The IRS and state tax agencies tax LLCs as sole proprietorships (for single-owner and husband-wife owned companies) or partnerships (for multi-owner companies).

The members of the LLC receive a K1, which essentially shows the net income produced by the asset where members receive a proportion based on their ownership percentage. For example, if the LLC has a loss of $20,000 with two members, each with a 50% stake, they would each get a K1 showing a loss of $10,000 for that year.

Each member then files the K1 tax form with their income taxes.

Tax Benefits of an LLC

The primary reason for creating an LLC is the tax benefits it allows.

If you plan to rent out your co-buy property as either a short-term rental on Airbnb or Vrbo or through a long-term, traditional lease (more than 30 consecutive days), you can expense most costs associated with the property. Common costs you can expense include:

  • General capital investments
  • Repairs
  • Furnishings
  • Supplies
  • Property management costs (if you use a property manager)
  • Additional costs can be dedicated like taxes, accounting services and fees associated with state/federal filings

Many co-buyers look to improve the property shortly after purchasing it. Whether painting the walls or replacing the appliances, the costs can be expensed. These expenses often completely offset the rental revenue.

As an example, let’s say you renovate the property’s kitchen.

  • The renovation costs $20,000
  • Your group’s rental revenue is $10,000 for the year year
  • This would be a net loss, and your group could deduct $10,000

While net losses sound scary, it’s good for your taxes, depending on the tax basis structure. You should consult a real estate-focused CPA firm like Balancedassetsolutions.com to understand how to structure your personal taxes and carryover losses over a period of time.

Other Business Structures

When choosing your business type, co-buyers can also choose structures like a C-Corp or S-Corp, which are not pass-through tax entities. In short, they’re complicated, require a lot of paperwork, and result in few tax benefits.

Unless you’re an experienced property investor with a portfolio of properties, few people benefit from a C-Corp or S-Corp. If you’d like to explore this option, consult a CPA or tax advisor.

Takeaway: Should your group form an LLC?

When you co-buy real estate, you’ll have many possibilities. Ultimately, it’s a personal decision but an LLC is a perfect solution for most co-buyer groups. An LLC is easy to form and maintain, and it offers the same tax treatments as an S-Corp but without complicated paperwork. Additionally, you should consider additional variables like if a trust fund will be associated with one of the owners or other potential downstream tax implications in the future.

Acknowledgement:
Balanced Asset Solutions is a technology-forward accounting firm that provides best-in-class property management accounting, bookkeeping and tax solutions to investment property owners. Whether your goal is to stabilize your investment or generate growth, Mo, Pedro and the entire team at Balanced Asset Solutions is here to serve you. Learn more at https://www.balancedassetsolutions.com/.

Nestment, Inc. does not guarantee and is in no way responsible for the accuracy of information provided in this blog post. All information is provided “AS IS” and with all faults. Data presented here may not reflect all real estate activity in the market.  While the information on this site is about legal and tax issues, it is not intended as legal or tax advice or as a substitute for the particularized advice of your own attorney and tax professional.