Inheriting a House and Converting to a Rental

Photo by Kevin Saff on Flickr.com

I’ve gotten this question a couple of time recently so I decided to post about it.  Here’s the question:

“My Dad died and my sisters and I want to keep the house and rent it out instead of selling.  How do we handle the taxes on this?”

First, you need to change over the house to your names. That’s important.  Get the house out of the estate before your rent it.  Also, some day you might sell or something; you want to fix that now.

Now—you and your siblings are going to become a partnership. I recommend becoming an LLC—that means Limited Liability Company. It gives you a little protection in case someone you rent to decides to sue you. Here in Missouri, it only costs $50 to file online. Do file in whatever state you actually live in though—don’t do one of those “file in Nevada” things you see online—big mistake, unless you actually live in Nevada.   File your LLC in the state you live in (or the state the house is in if that‘s different.)

After you file for your LLC, you will want to get an EIN number. Here’s information on that: http://robergtaxsolutions.com/2010/11/how-to-get-an-ein-number-for-your-business-for-free/ .  Because you have a partnership, you’ll need the EIN number to file a tax return.

You will also want to have a separate bank account for the partnership. You’ll use the EIN number to set up that bank account. It’s important to do that. If you use your personal bank account for the LLC then you have (legalese here) “pierced the veil” of the LLC.  That means if there was an issue, then you could be sued personally—so the bank account is important.

Okay, so now you’ve got the LLC, the EIN, and the bank account. You rent out the house, the tenant writes checks to the partnership, and the partnership pays bills out of the bank account—all good.  If you have a profit, the partnership can make distribution payments to you and your sisters (the partners.)

At tax time you will file a partnership return, Form 1065. They’re due to the IRS by April 15th, but really they need to be done before then because you need that information to file your personal return.

The partnership will issue a K-1, tax form to each of the partners. The K-1 form is how you report the partnership income on your personal return so that you can pay your share of the taxes.  Let’s say the house had a profit of $5001. The three of you are equal partners, so you’d each get a K1 saying that you had a profit of $1,667 that you would report on your personal tax return. Or if there was a loss, you’d report the loss which would offset your other income.)

As long as you and your siblings all agree, you should be okay. You might want to sit down together and write out some stuff like, what happens if one of the partners wants out? Who’s going to run the rental (collecting rent, making sure house is okay and stuff). Does the person managing that get paid something extra?

You are not required to have an attorney write up a partnership agreement. (You might want one, but it’s not required.) But do think through potential problems and decide how to solve them before you start. Example: what happens if one of the siblings falls on difficult financial times and needs to sell her share of the house? How will you handle that? A partnership is kind of like a wedding.  It’s easier to get into than to get out of.  Planning ahead will make those transitions easier.