Chapter 1 Frequently Asked Questions

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here are some FAQs you might find helpful as a chapter summary for ownership arrangements with rental properties and real estate investments-

Is rental property considered a business?
Yes. Rental property, when managed with a profit motive and regular effort, is considered a business under IRS Section 162, especially if you materially participate.

What are the main business entities used in real estate?
LLCs, partnerships, and C corporations are common. LLCs are favored for flexibility and liability protection, while C corps are rarely used due to double taxation (but are good in a debt reduction environment).

Is an S Corporation an entity?
No. S Corp is a tax election, not a legal entity. It’s usually applied to an LLC or corporation to reduce self-employment taxes on earned income. Rental income is not subject to self-employment taxes.

Is an LLC necessary for each rental property?
Not required, but recommended. It provides liability protection, organizational clarity, and easier ownership transfers. But there are costs, and potentially high ones in certain states.

What are the primary benefits of putting a rental property in an LLC?
An LLC provides liability separation, potential anonymity, structured wealth transfer through an Operating Agreement, and compartmentalization of finances—all of which help streamline ownership and reduce risk.

Can I avoid transfer taxes by selling my LLC interest instead of the property?
Possibly. In some jurisdictions, selling your interest in the LLC (instead of the property itself) may bypass transfer taxes, but it comes with complexity and may limit the buyer’s ability to reset depreciation.

Should I form a new LLC for each rental?
Often, yes. This improves liability segregation and simplifies ownership structures, especially with higher-risk or out-of-state properties.

Should I put my rental property in an S Corp?
Generally, no. S Corps aren’t ideal for holding appreciating assets like rentals due to issues with asset distribution and limited deduction options.

Do I need a partnership return for a rental owned with my spouse within an LLC?
It depends. In community property states, you may file jointly without a partnership return. Otherwise, a Form 1065 is often required.

Can a rental property in a partnership reduce audit risk?
Yes. Partnerships (Form 1065) have a lower audit rate than individual returns and offer clearer tracking of partner basis and losses.

Can a partnership help with estate planning?
Yes. Multi-member LLCs can simplify gifting, ownership transfer, and valuation discounts when used properly with an Operating Agreement.

Can I add my child as a partial owner?
Yes, but with care. It allows income shifting and gifting strategies, but be aware of potential tax and control implications.

What are the downsides of owning rentals in a partnership?
Higher tax return preparation costs, complexity, and state filing fees. Partnerships also require additional record-keeping for capital accounts and contributions.

Can you mix short-term, long-term, and vacation rentals in one partnership?
You can, but it complicates taxes. Each type has different rules for deductions and loss limitations, which can get tangled in a single return.

Do partnerships limit Section 179 deductions?
Yes. Partnerships can’t use Section 179 to create or increase a loss, unlike individuals reporting directly on a Schedule E.

Should I add my spouse as a co-owner in the LLC?
Only if necessary. It’s rarely needed for tax purposes unless for asset protection or succession planning.

What’s a capital account in a partnership?
A capital account tracks each partner’s investment in the business, including cash contributions, allocated profits, and personal payments.

Do partnerships need a formal agreement?
Yes, ideally. An Operating Agreement outlines ownership percentages, income splits, and procedures for disputes or exits.

Can a rental LLC be owned by a trust?
Yes. A trust can own an LLC interest, providing probate avoidance, continuity, and asset control after death.

Can a rental property lose money and still benefit me tax-wise?
Yes. With sufficient basis and material participation, losses may offset other income especially in short-term rental loophole or real estate professional scenarios.

Is real estate a good tax shelter?
Yes, but the primary function of a rental property or real estate investment is to build wealth.