"Unofficial" Partnership

[Patrick Michael]

Potential new client came in today.  Former preparer has retired.  Potential client and a friend bought a mini-storage facility together many years ago.  There is no formal partnership agreement but they split everything 50/50.  Property is listed in potential clients name and social.  The former preparer did both "partners" personal returns and just split all the revenue and expenses 50/50 on a Schedule E.  This does not seem right to me.  Even if there is no formal agreement shouldn't a 1065 and K-1's be prepared?  What would be the consequences if the IRS audited the returns and determined that the 1065 should have been done? Should past partnership be prepared and 1040's be amended?

 

Thanks for any thoughts.

 

Pat

[DANRVAN]

Are you saying that they bought the property together but it is only in one partner's name?

[OldJack]

 Property is listed in potential clients name and social.

Pat

 

What would you accomplish by filing a partnership return now?

[Abby Normal]

What would you accomplish by filing a partnership return now?

More billing and letting the public know you know how to prepare returns.

[michaelmars]

could be a t-I-c, I would do a 1065 going forward, make sure they have a partnership agreement.  is their a bank involved? maybe that's why one "partner" wanted to be invisible.  this sounds like a post 4/15 issue

Edited March 23, 2015 by michaelmars

[Abby Normal]

What would be the consequences if the IRS audited the returns and determined that the 1065 should have been done? Should past partnership be prepared and 1040's be amended?

Fortunately, with partnerships there is automatic removal of penalties for late file partnership returns, so an audit should result in no penalties or tax.

[Abby Normal]

Does the partnership have a joint checking account? Or even a separate checking account at all?

[Terry D EA]

I have one of these without a formal partnership where both individuals have invested 50% each into rental properties and both of their names exist on the property deeds. Splitting the income and expenses 50/50 is the same result as having a formal partnership using form 1065. I have suggested many times to create a formal partnership and partnership agreement but they do not want to so they can avoid paying the State annual report fees.

[Lion EA]

TTB:  Co-ownership.  Co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.  Sharing expenses.  A joint undertaking merely to share expenses is not a partnership.

 

The above comes from two separate paragraphs.  Co-ownership may not be what your clients have.  A joint undertaking may be what your clients have.  I think intent is important, especially if no partnership nor operating agreement exists.  Ask lots of questions!

[Lee B]

I had almost the exact same scenario a number of years ago except there were 3 brothers involved.

 

The CPA who prepared the returns before me just divided everything in thirds on each 1040's Schedule E

 

So after I had prepared the returns the same way for 2 or 3 years the IRS sent the three brothers

 

the same letter and insisted that a partnership return had to be filed going forward.

[Terry D EA]

In my scenario, both individuals provide services to the tenants.

[joanmcq]

Should be biz income. No way qualifies for the Sch. E treatment.

[grandmabee]

Why would this not be Schedule E  rental of commercial property?

[Terry D EA]

It is Sch E and we have been filing this way for the last two years without question. Both of these guys are active individuals with managing, repairing, renting; etc these properties. Mortgages are in both names as well. I agree a partnership would be the way to go here but until they tell me to do so or we get some kind of notice it will stay the way it is. If someone has a resource to show me differently and that there is an issue with this please post it for me.

[kcjenkins]

What kind of services, Terry?   Normal 'rental' activities like managing, repairing, renting, are not the sort of things that the IRS considers 'services'.  I think what you have sounds like a classic 'joint venture'.  If you materially participate in the daily operations of the rental properties, then the IRS will treat you like a business. Material participation requires your involvement in the management of the properties or the frequent provision of services to tenants, such as daily cleaning of apartments or changing of linens. However, if you only provide utility and trash collection services, this is a passive activity.

 

IRC Section 7701(a)(2) provides that the term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or organization.

 

Whether a joint venture is a separate entity for federal tax purposes is a question of federal law. Treasury Regulation Section 301.7701-1 prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law. In addition, certain joint undertakings give rise to entities for federal tax purposes. A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits.

For example, a separate entity exists for federal tax purposes if co-owners of an apartment building lease space and in addition provide services to the occupants either directly or through an agent. Nevertheless, a joint undertaking merely to share expenses does not create a separate entity for federal tax purposes. For example, mere co-ownership of property that is maintained, kept in repair, and rented or leased does not constitute a separate entity for federal tax purposes. For example, if an individual owner, or tenants in common, of farm property lease it to a farmer for a cash rental or a share of the crops, they do not necessarily create a separate entity for federal tax purposes.

 

For failure to file partnership returns. see IRC Sections 761 and 6698.