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LLCs and Negative Rental Cashflow

David’s question:

The borrower has two rentals owned by separate LLCs and reported on the 1040 Schedule E. If I treat the rentals as if they are partnership/S Corp rentals because they are owned by the LLC and not the individual, I can show the negative cashflow as a reduction to overall cashflow. If I treat them as if they are personally owned, I have to treat the negative rental cashflow as a liability. Which should I do?

Linda says:

If a business or a rental property is owned by a one-owner LLC it is reported in the 1040 as if owned personally. Most lenders cashflow it as if it is owned personally, as well. So I would say do it the way you would if the rental was listed in the 1040 except I have a problem with that.

What tax return does an LLC file?

First, let me cover the LLC filing rules. One-owner LLCs file directly in their personal 1040 as if they owned it personally. This is true whether it is a rental as in your example or a business. If there are two owners and they are married, the same applies. But if there are two unmarried owners, the LLC must file a separate return. Here is where it can get confusing, for your borrower and for you.

The LLC chooses what tax return it will file when it is created. While a two-plus owner LLC often files a 1065, it could file an 1120 or an 1120S as well. When you see an 1120S you assume an S Corporation, but really, it could also be an LLC. The good news for us, you can calculate the cash flow based on the type of return they are filing.

How is an LLC filing a 1065 different than a partnership?

The big difference is risk mitigation for the owners. A 1065-filing LLC is similar to a corporation in that the owner’s liability is limited if they have not guaranteed a loan/contract personally. A 1065-filing general partnership is similar to a sole proprietorship in that the owners have unlimited liability. So it is more about the legal entity type than it is what tax return they are filing.

Mortgage Loans: Subtract negative cash flow or put it on the debt list?

So back to your question. You asked if the negative rental cashflow should be subtracted from other cashflow or entered as a liability, as it would be in your process if the rental had been in the 1040 on Schedule E. Entering it as a reduction to income instead of adding the negative rental cashflow as a liability may be the difference between making the loan and not making the loan.

If counting the loss as a liability kills the deal, double check with your guidelines (or the lender you are pitching this to if you are selling a mortgage loan) as to how it must be treated. I’ve seen it done either way, especially if the loan looks good otherwise as in the case when there are some nice compensating factors.

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.