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The scenario is that individual I is a member of LLC L, and L owns property P. L distributes profits and losses to I. I rents P from L.

An obviously significant free variable is how much rent L charges I.

If the rent I pays to L results in an increase in the profits of L, would I be liable for an increase in taxes from the distributed share of those profits? If L is operating at a loss, and I is paying rent substantially below market rate (say 1USD per month), what could the tax-related consequences be?

Edit: This is not homework. I am not currently a student. If it helps stimulate answers, consider first the general case where an LLC's member is also a customer of the LLC (not necessarily related to real estate); second, the case where the member's expense would have tax implications for the member independent of their membership in the LLC; and third, the case where the tax implications arise due to their membership (e.g. home office or commercial property for a non-competing company). I recognize that this question may also have other legal or ethical implications that are explicitly not in scope.

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    If I distributed his profits P to O then you could have an IPO. Barring that, is this homework? – Bob Baerker Oct 26 at 22:37
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Well, in theory if the rent charged is less than "market price" (whatever that means) then it can be considered income.

In practice, it is hard to prove that some rent is below market rates and from a bureaucratic point of view, the amount of man hours the IRS would have to spend to prove that you are getting unfair income is pretty substantial.

The bottom line is that as long as you pay a rent that is even vaguely reasonable you are ok. You will only be vulnerable in an audit if the rent you are paying is egregiously low (like less than 10% of market value).

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If I rents below market value, that's ugly. Don't do it. If I receives a salary, increase his salary and make him pay full rent. If I doesn't receive a salary, pay him a dividend. If L reduces the rent, this will be treated either as salary or a dividend. So we assume the rent payment is fair.

L's profit will increase by the rent minus cost. L will have to pay taxes on its profits, and more taxes on more profit. If there are losses, then the rent reduces the losses. In either case, L is responsible to pay taxes on its profit. I has no responsibility for L's increased profits. That would be stupid. That would mean that when I go to a restaurant and increase the restaurant owner's profits, I would be responsible for that. Of course I'm not.

If I pays reduced rent, and the inland revenue loses out on taxes because it is not told, that would be tax evasion.

PS. The LLC L is responsible to pay taxes for its profits. And it should be able to do so, because after all it made profits. If the members decided to pay themselves so much money in dividends that the LLC is not capable of paying its taxes anymore, that would be illegal in most countries. Most likely the members would have to return their dividends so that the LLC can pay its taxes.

PPS. Reading some comments, I think I need to make clear one important principle: An LLC and its members are legally totally separate entities. Whether someone is a member of the LLC or not makes legally very little difference.

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    "L is responsible to pay taxes on its profits." My understanding is that in most cases L's members are responsible to pay taxes of L's profits, not L itself. Is the conclusion that I should pay a rate exactly equal to L's expenses (assuming that rate could be determined for P)? Anything less would be evasion, and anything more would be bad business. – neirbowj Oct 27 at 3:39
  • Is there a reason for the...unusual subject-verb (dis-)agreement in the first and last paragraphs? I would edit, but the changes would have to go through review. – mkennedy Oct 27 at 17:07
  • @mkennedy If you mean "If I rents..." and "If I pays..." then remember the "I" is not the personal pronoun "I" but is standing for "the individual who is a member of LLC L". Copying the OP's bolding: "If I rents..." and "If I pays..." would probably help. In fact, I'll edit that in. – TripeHound Oct 28 at 9:17
  • @TripeHound Thank you! I had missed that. – mkennedy Oct 28 at 21:57

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