Capital Gains Offsets With LLC Operating Losses

LLC members must consider the advantages and disadvantages of being taxed at a partnership or corporate level.

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When a limited liability company, or LLC, incorporates, the members must decide how the LLC will be taxed. An LLC with only one member is taxed as an individual. An LLC with two or more members can elect to be taxed as a partnership, a C corporation or an S corporation. The type of election determines how the business's capital gains will offset its capital losses. Each LLC member should take her individual tax liability into consideration before deciding how LLC capital gains tax will be accounted for regardless of whether utilizing capital gains real estate investments or otherwise.

Finding More About Disregarded Entities

Unless a single-member LLC makes the election to be taxed as a corporation, the IRS will consider the LLC a “disregarded entity.” A disregarded entity is not recognized as being separate from the owner for taxation purposes. In this case, the LLC’s capital gains and losses are treated as though directly incurred by the individual. The capital gains and losses are reported on Schedule D along with any other capital gains and losses. Net LLC capital gains tax is determined at the individual taxpayer’s rate. Net losses are deductible up to the IRS limits.

Looking For Additional Tax Arrangements

LLCs that choose to be taxed as a partnership will not recognize any profits or losses but pass them through to each partner based on the partner’s ownership percentage. The capital gains and losses will offset each other. The net capital gain or loss is reported on Schedule K of Form 1065, U.S. Return of Partnership Income. A partner’s basis will offset the capital gain up to the basis amount. Each partner will receive a K-1 showing the amount of capital gain or loss that can be deducted on his individual tax return.

LLCs electing to be taxed as S corporations will pass their profits and losses through to the individual shareholders. Any capital gain will be considered a return of a shareholder’s basis in the LLC. The basis will offset the amount of capital gain that is distributed. The capital gain or loss is reported on the shareholder’s K-1. This amount must be reported on the shareholder’s Schedule D on her individual income tax return. If a shareholder engages in the sale of membership interest in LLC, this will likely be taxed as if it were personal income. The shareholder can claim the losses, but the amount may be subjected to passive activity loss limits.

Obtaining More Information About Dual Taxation

LLCs that elect to be taxed as a C corporation are subject to dual taxation. If capital gains exceed capital losses, the net gain is considered ordinary income and added into the LLC’s other income. If capital losses exceed capital gains, the amount is carried back for the previous three years. Any remaining capital losses can be carried forward for up to five years. The LLC pays taxes on capital gains at the corporate rate. Profits are paid out in dividends, and the LLC members will pay taxes on the dividends at their individual tax rates.

Reporting Your Taxes

If your LLC is composed of a single individual, all income and qualifying expenses should be reported using Form 1040. However, if the LLC is composed of a corporation, all income and expenses are reported using the return for the corporation. This is typically Form 1120 or 1120s.

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About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.


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