Entities and Who Gets the Deduction

The deduction from a study belongs to the taxpayer that owns the property for tax purposes. Depending on how you hold title, that might be you directly, or it might flow through an entity to owners who then face their own limits. This page explains the basics.

Direct ownership and disregarded entities

If you own a property individually, or through a single-member LLC that is disregarded for tax purposes, the depreciation is reported on your own return. Your participation and income determine usability. This is the simplest case.

Partnerships and multi-member LLCs

A partnership, including a multi-member LLC taxed as a partnership, computes depreciation at the entity level and allocates it to partners under the partnership agreement and tax rules. Each partner then applies their own basis, at-risk, and passive limits. A partner who is a passive investor may have their share suspended. A partner who materially participates might use it. The agreement may allocate depreciation in particular ways, subject to rules requiring substantial economic effect. See Multifamily Properties: The Study Decision.

S corporations

An S corporation passes through items to shareholders proportionately. Shareholder basis limits apply. S corporations generally have less flexibility in allocations than partnerships. Holding appreciating real estate in an S corporation can have drawbacks, so this is an area for careful advice.

C corporations

A C corporation is taxed on its own income. Depreciation reduces the corporation's income. Passive loss rules apply to certain closely held corporations in specific ways. A corporation's owners do not receive pass-through losses. Ownership of real estate in a C corporation raises other considerations, such as the tax on a sale and on distributions.

Trusts and estates

Trusts and estates can own property and face their own rules, including how participation is measured. Ask your advisor.

Married couples

Spouses filing jointly combine income. Participation tests may combine spouses' time for certain purposes, but real estate professional status has its own rule. See Real Estate Professional Status and Study Decisions.

Investor perspective

If you are considering investing in a partnership that is expected to obtain a study, ask about the expected deductions, how they will be allocated, and whether you would be able to use them. Do not assume the deduction is valuable to you. See Tax Bracket and Whether Deductions Are Usable.

Sponsor perspective

If you sponsor investments, consider how a large first-year deduction affects investors with different profiles. Communicate clearly about what may or may not be usable. Avoid promising particular tax results.

Tiered structures

Ownership through multiple tiers of entities can make it more complex to trace basis and participation. Keep records.

Contributing property

If you contribute property to an entity, basis and depreciation continue under special rules, and the study might need to reflect the contributed basis.

Documentation

Keep the operating or partnership agreement, capital account records, and allocations. See Audit Defense and Documentation for Cost Segregation.

Illustrative situations in words

A husband and wife own a rental through a single-member LLC that is disregarded. The deduction goes on their joint return. Three friends own a building through an LLC taxed as a partnership. The operating agreement allocates depreciation in proportion to ownership. Each friend has a different income and participation. One is a real estate professional and can use the loss. Another has passive income from other properties and can use part. The third is a passive investor with no other passive income, and the loss is suspended. The same study produces three different results.

Special allocations

Partnership agreements sometimes allocate depreciation differently from profits. The tax rules require that allocations have substantial economic effect or be in accordance with partners' interests. If your agreement has special allocations, ask whether a study affects them. Agreements should be reviewed by counsel and your preparer before the study.

What sponsors should communicate

Sponsors should tell investors what to expect and avoid promising tax results. Investors should ask sponsors for the study summary and allocations. Investors should ask their own advisors whether their share would be usable.

Change in ownership

When an interest is sold or transferred, the depreciation schedule and recapture follow the entity or the interest, depending on the structure. Ask before transferring.

Questions for the operating agreement review

Does the agreement address tax elections, including elections out of bonus? Who decides whether to order a study? Who pays? How are the tax benefits shared? Does the agreement require distributions to cover taxes? Are there restrictions on transfers? Resolve these before ordering, since disputes after the fact are harder to solve.

Entity-level and owner-level filings

Entity returns must reflect depreciation correctly and pass the right items to owners. Owner returns must reflect their limits. Coordination between the entity's preparer and owners' preparers avoids errors.

A note on lenders and guarantees

Personal guarantees and the structure of debt can affect at-risk and basis computations. If you guarantee a loan, ask how that changes your amounts. Do not assume guarantees automatically increase deductible losses.

Next steps

Read At-Risk and Excess Business Loss Limits for the basis and at-risk layers, and Questions to Ask Your CPA Before Ordering a Study to plan a conversation.