Many married couples form an LLC to own rental property to obtain liability protection. After they create the LLC, they often ask an important tax question: Does the LLC force them to file a partnership return?
The answer depends largely on where they live and how they own the property.
Federal tax rules treat any unincorporated business with two owners as a partnership by default. When a husband and wife form a two-member LLC, the IRS normally requires a partnership return on Form 1065. Some exceptions exist, but most couples do not qualify for them.
Tax law allows “mere co-ownership” of real estate without creating a partnership. This rule applies only when individuals own property directly as tenants in common and simply maintain and rent it. Once spouses place the property inside a multi-member LLC, they move beyond co-ownership and create a separate tax entity. At that point, the partnership rules apply.
Spouses sometimes ask about the qualified joint venture election. That option lets qualifying couples file a single Schedule E instead of a partnership return. Unfortunately, the election does not apply when spouses operate a rental through an LLC or any other state-law entity.
Spouses who live in community property states have more flexibility. In those nine states, married couples may treat an LLC-owned rental as a single disregarded entity and file one Schedule E. The other 41 states do not offer this option.
In those 41 states, the husband-and-wife LLC result stays clear: they must file a partnership return and issue Schedule K-1s.
Before forming an LLC, couples should weigh the liability protection against the added tax filing complexity.
If you want to discuss an LLC, please get in touch with us at hello@agfintax.com.
