A landlord collecting $8,000 a month in rent pays zero self-employment tax on that income. A flipper who nets $80,000 on a rehab pays 15.3% in SE tax plus ordinary income rates. Same industry. Same dollar amounts. Completely different tax treatment. I walk clients through this distinction every week because it determines which entity structure makes sense, which deductions apply, and how much you actually keep.
One boundary first. I am a real estate lawyer, not your CPA. I form the entity, draft the operating agreement, and prepare the deed. Your CPA prepares the return and signs it. This page explains the rules so you can ask your CPA better questions. The section on when to bring in a CPA is in the middle of the page.
Rental income goes on Schedule E. It does not carry the 15.3% self-employment tax. You depreciate the building over 27.5 years, and you never depreciate the land. A rental loss is a passive loss. If you actively participate, up to $25,000 of it can offset your wages. That allowance shrinks above $100,000 of adjusted gross income and is gone at $150,000. Illinois taxes your net rental income at 4.95%. A multi-member LLC also owes a 1.5% replacement tax.
The Two Types of Real Estate Income
The IRS does not see "real estate income." It sees two fundamentally different categories, and it taxes them under different rules. The distinction comes down to one question: are you holding the property or selling it?
If you buy a property, rent it out, and collect monthly income, that is passive rental income. It flows through Schedule E on your personal return. In the ordinary case it is not subject to self-employment tax, because IRC Section 1402(a)(1) excludes "rentals from real estate" from net earnings from self-employment. That exclusion has limits, covered below. When you eventually sell, the appreciation is taxed at capital gains rates (0%, 15%, or 20% depending on your income), but the part of the gain that represents depreciation you already deducted is unrecaptured Section 1250 gain and is taxed at up to 25% under IRC 1(h)(1)(E).
If you buy a property, renovate it, and sell it for profit, that is dealer income (also called ordinary business income). It flows through Schedule C. It is subject to self-employment tax at 15.3%. The profit is taxed at ordinary income rates, not capital gains rates. And you cannot use a 1031 exchange to defer the gain, because dealer property is explicitly excluded from 1031 treatment.
The gap between those two columns is enormous. On $100,000 in profit, the rental investor pays zero SE tax and gets long-term capital gains treatment on the appreciation when they sell. The flipper pays about $14,130 in SE tax (15.3% of the 92.35% statutory base set by IRC 1402(a)(12)) and ordinary income rates on the entire profit. Over a career with multiple transactions, the difference runs into the hundreds of thousands.
How Rental Income Is Taxed
Rental income is the simpler of the two. You collect rent. You subtract your expenses (mortgage interest, property taxes, insurance, repairs, management fees, depreciation). The net income flows to Schedule E and gets added to your personal income on your 1040. You pay federal and state income tax at your marginal rates, but you do not pay self-employment tax.
The self-employment tax exclusion is not a loophole or a planning strategy. It is a specific statutory exclusion under IRC 1402(a)(1). Rental income from real estate is excluded from the definition of "net earnings from self-employment." The statute carves out its own exception in the same sentence: the exclusion does not apply where the rentals "are received in the course of a trade or business as a real estate dealer." The regulations add a second carve-out, for payments for the use of rooms or space where you also render services to the occupant, which is how substantial-service short-term rentals commonly get treated. If you are running two flips a year alongside a rental portfolio, or renting nightly with cleaning and concierge service, do not assume the exclusion holds. How your LLC allocates profit and loss among members is governed by your operating agreement, which is also where you document the entity's tax election. I covered this in detail on my LLC vs. S-Corp page because it is the reason S-Corp elections are pointless for landlords.
Notice the last column. Zero self-employment tax. That $38,000 in net rental income is taxed at your marginal federal rate (22% in this example) plus Illinois's flat 4.95%, but the 15.3% SE tax does not apply. On this example, that saves about $5,370 compared to active business income. (SE tax runs 15.3% on 92.35% of net earnings under IRC 1402(a)(12).)
Illinois adds its own layer. A multi-member LLC owes a 1.5% replacement tax on top of the members' 4.95%. I cover both rates in the Illinois section below.
There is one additional federal tax to watch for. The 3.8% Net Investment Income Tax under IRC 1411 applies to the lesser of your net investment income for the year or the amount by which your modified adjusted gross income exceeds the threshold: $250,000 filing jointly, $125,000 married filing separately, $200,000 in any other case. Those thresholds are not indexed for inflation, so more landlords cross them every year. Crossing the line does not mean the full 3.8% lands on all of your rental income. It also does not automatically catch rental income at all: Section 1411(c)(1)(A)(i) excludes rents derived in the ordinary course of a trade or business that is not a passive activity, and Section 1411(c)(2) ties the passive question to Section 469. A landlord who materially participates in a rental trade or business may owe no NIIT on the rents. Once you add W-2 income to rental net income, most owners in the three-to-five property range are over the MAGI threshold, so the question worth asking is not whether you cross it but whether your rentals are net investment income in the first place.
Schedule E: Where Rental Income Lands on Your Return
Who holds the title decides which forms you file. The tax on the rent changes very little. The paperwork changes a lot.
| How you hold it | Federal return | Where rent lands |
|---|---|---|
| Your own name | Your Form 1040 | Schedule E, Part I |
| Single-member LLC | Your Form 1040 | Schedule E, Part I |
| Multi-member LLC | Form 1065, then K-1s | Schedule E, Part II |
| LLC taxed as S corp | Form 1120-S, then K-1s | Schedule E, Part II |
Source: IRS, 2025 Instructions for Schedule E (Form 1040). Part I reports rental real estate. Part II reports your share of partnership and S corporation income.
A single-member LLC is a disregarded entity for federal income tax. Under Treas. Reg. 301.7701-2(c)(2)(i), a single-owner LLC "is disregarded as an entity separate from its owner." The IRS looks through the LLC to you. The LLC still matters for liability under Illinois law.
An LLC with two or more members is a partnership by default under Treas. Reg. 301.7701-3(b)(1)(i). Two spouses are two members. The LLC files its own partnership return. Each member gets a Schedule K-1 and reports it on Schedule E, Part II. That second return costs money every year. Count that cost before you add a member.
Depreciation: 27.5 Years, and Never the Land
Depreciation is a deduction that costs you no cash in the year you take it. It still reduces your taxable rental income every year.
IRC 168(c) sets the recovery period for residential rental property at 27.5 years. IRC 168(b)(3) requires the straight line method. IRC 168(d)(2) applies the mid-month convention, so the first year is prorated by month. A commercial building uses 39 years.
A building is residential rental property if 80% or more of its gross rental income comes from dwelling units. That test is in IRC 168(e)(2)(A). A mixed-use building with a large storefront can fail it and fall into the 39-year class.
Land never depreciates. Treas. Reg. 1.167(a)-2 limits the allowance to property subject to wear and tear. It excludes "land apart from the improvements." So you split the purchase price between land and building first. IRS Publication 527 makes the split by fair market value. If you are not certain of those values, it allows the ratio from your property tax assessment.
| Example step | Amount |
|---|---|
| Purchase price | $400,000 |
| Less land (example split) | $100,000 |
| Depreciable building | $300,000 |
| Yearly deduction ($300,000 divided by 27.5) | $10,909 |
| Ten full years of deductions | $109,091 |
Illustration only. Full years shown; the first and last years are prorated under the mid-month convention. The land share is an assumption, not a Chicago average.
IRC 1016(a)(2) lowers your basis by the depreciation "allowable," even if you never claimed it. Skip it and you lose the deduction. Your gain at sale still grows as if you took it. Ask your CPA how to catch up missed years.
Some parts of a rental recover faster than the building. IRS Publication 527 puts appliances, carpeting, and furniture in a residential rental in the 5-year class. Fences and shrubbery, if depreciable, are 15-year property. A cost segregation study finds those parts. IRC 168(k) allows 100% bonus depreciation on property with a recovery period of 20 years or less. The 2025 tax law (Pub. L. 119-21) restored the 100% rate for property acquired after January 19, 2025. The building itself, at 27.5 years, does not qualify. A cost segregation study is CPA and engineer work. I raise it so you know to ask.
Passive Loss Rules: The $25,000 Allowance and Its Phase-Out
Depreciation often turns a rental with positive cash flow into a tax loss. That is where IRC 469 starts to matter.
IRC 469(c)(2) treats every rental activity as passive. IRC 469(c)(4) applies that rule even if you work hard at the property. By default, a passive loss offsets only passive income. It does not offset your wages.
The loss does not disappear. IRC 469(b) carries it forward to the next year. IRC 469(g) releases the suspended loss when you sell your entire interest in the activity in a fully taxable sale. A sale to a related party does not release it, under 469(g)(1)(B).
The $25,000 exception for active participation
IRC 469(i) gives small landlords an exception. If you actively participate, up to $25,000 of rental loss can offset other income each year. IRS Publication 925 calls active participation a less stringent standard than material participation. Approving new tenants, deciding rental terms, and approving expenses count. You must also own at least 10% of the property, counting your spouse's share, under 469(i)(6)(A).
The allowance shrinks as income rises. IRC 469(i)(3)(A) reduces it by 50% of your adjusted gross income above $100,000. At $150,000 it reaches zero. Under 469(i)(3)(E), that income figure is computed before the passive loss itself.
Source: IRC 469(i)(2) and (3)(A). Married filing separately: $12,500, phased out from $50,000, and only if you lived apart all year, under 469(i)(5).
Illinois starts from your federal adjusted gross income under 35 ILCS 5/203(a)(1). So the federal passive loss limits carry into your Illinois return.
Nightly rentals follow a different path. Treas. Reg. 1.469-1T(e)(3)(ii)(A) covers property whose average period of customer use is seven days or less. That property is not a "rental activity" under 469. It is tested like any other business, under the material participation rules. Ask your CPA before you count on either result.
Real Estate Professional Status, Briefly
Real estate professional status takes the automatic passive label off your rentals. IRC 469(c)(7)(B) sets two tests. You must pass both in the same year:
- More than half of your work time goes to real property trades or businesses where you materially participate.
- You spend more than 750 hours in those real property trades or businesses during the year.
On a joint return, one spouse must pass both tests alone. Work as an employee does not count unless you are a 5-percent owner of the employer, under 469(c)(7)(D)(ii). If you work 2,000 hours at a W-2 job, you need more than 2,000 real estate hours too.
Passing the two tests is only the first step. You must also materially participate in the rentals. IRC 469(c)(7)(A) treats each rental property as a separate activity. You may elect to treat all of them as one activity. Treas. Reg. 1.469-9(g) makes that election binding for later years. Without it, you must materially participate in each property separately.
Treas. Reg. 1.469-5T(f)(4) lets you prove hours by any reasonable means. The burden of proof stays with you. Record your hours during the year, not after an audit letter arrives.
The QBI Deduction and the Rental Safe Harbor
IRC 199A allows a deduction of up to 20% of qualified business income. Rental income can qualify. The rental must rise to the level of a trade or business.
The 2025 tax law (Pub. L. 119-21) struck the provision that ended the deduction after 2025. The deduction is now permanent.
A single rented house may or may not be a trade or business. Rev. Proc. 2019-38 gives landlords a safe harbor. If you meet it, the IRS treats your "rental real estate enterprise" as a trade or business for 199A. The requirements apply each year:
- Keep separate books and records for the rental enterprise.
- Perform 250 or more hours of rental services per year. After four years, meet that in three of the last five years.
- Keep contemporaneous records of the hours, the services, the dates, and who did the work.
- Attach a statement to a timely filed original return.
Hours by your property manager, employees, and contractors count. Time spent arranging financing or traveling to the property does not. Residential and commercial properties cannot share one enterprise.
Three kinds of property cannot use the safe harbor. Property you use as a residence under IRC 280A(d) is out. A triple net lease is out. Property rented to a business you commonly control is out.
Failing the safe harbor does not end the question. Rev. Proc. 2019-38 says the rental can still qualify if it meets the general trade or business definition. Above an income threshold, a limit based on W-2 wages and property basis applies under 199A(b)(2)(B). Your CPA runs that math.
Illinois Tax on Rental Income
Illinois taxes individuals at a flat rate. 35 ILCS 5/201(b)(5.4) sets it at 4.95% of net income for taxable years beginning on or after July 1, 2017.
Entities can owe a second tax. 35 ILCS 5/201(c) imposes the Personal Property Tax Replacement Income Tax "on every corporation (including Subchapter S corporations), partnership and trust." Section 201(d) sets the rate at 1.5% for "a partnership, trust or a Subchapter S corporation." A regular corporation pays 2.5%.
| How you hold it | Owner pays | Entity pays |
|---|---|---|
| Your own name | 4.95% | Nothing |
| Single-member LLC | 4.95% | Nothing |
| Multi-member LLC | 4.95% on your share | 1.5% replacement tax |
| LLC taxed as S corp | 4.95% on your share | 1.5% replacement tax |
| C corporation | Tax on dividends | 7% plus 2.5% |
Source: 35 ILCS 5/201(b)(5.4), (b)(14), (c) and (d). The single-member row assumes a disregarded LLC; 35 ILCS 5/1501(a) follows the federal classification of an LLC.
So a two-member rental LLC carries about 6.45% of Illinois tax on its net income, not 4.95%. A single-member LLC avoids the replacement tax. That is a real reason to think about how many members your LLC needs.
Partnerships and S corporations may also elect the Illinois pass-through entity tax under 35 ILCS 5/201(p). The entity pays 4.95% on its net income. Each owner then takes a credit for 4.95% of their share. The election is made separately each year, and it cannot be revoked once made. Whether it saves you money is a question for your CPA.
I Am a Real Estate Lawyer, Not Your CPA
I do not prepare tax returns, and I do not sign them. I explain these rules because they shape how I draft your LLC and your deed. A CPA should own the numbers on your return.
Bring in a CPA before you act if any of these is true:
- Your rentals show a loss, and your adjusted gross income is over $100,000.
- You want to claim real estate professional status.
- You want the QBI deduction under the rental safe harbor.
- You are considering a cost segregation study or bonus depreciation.
- You plan to sell a rental or start a 1031 exchange.
- Your LLC has two or more members, or a member outside the United States.
- Someone suggested an S corp election for a rental. Read my LLC vs. S corp comparison first.
My side is the legal structure. I form the LLC and write the operating agreement, including its allocation terms. I also prepare the deed into the LLC.
I form rental LLCs for a $750 flat fee, state filing fee included.
How Fix-and-Flip Income Is Taxed
I spend more time explaining flip taxes than any other topic in my practice. A flipper who buys a distressed property, renovates it, and sells it at a profit is not an "investor" in the eyes of the IRS. The IRS classifies that person as a dealer. The property is "inventory," not a "capital asset." And the profit is ordinary income, not capital gain.
The tax consequences of dealer status are severe. The profit is reported on Schedule C. It is subject to the full 15.3% self-employment tax (12.4% Social Security up to the wage base, plus 2.9% Medicare with no cap). It is taxed at ordinary income rates, which can reach 37% federally. And the property cannot qualify for a 1031 exchange. IRC Section 1031(a)(1) allows nonrecognition only for real property "held for productive use in a trade or business or for investment," and Section 1031(a)(2) then says flatly that "this subsection shall not apply to any exchange of real property held primarily for sale." Dealer property is held for sale to customers, so it is excluded twice over.
Take an $80,000 flip profit for a single filer in the 24% bracket. Self-employment tax is not 15.3% of $80,000. IRC 1402(a)(12) computes net earnings from self-employment on 92.35% of the profit, so the base is $73,880 and the SE tax is about $11,304. You then deduct half of that, about $5,652, above the line under IRC 164(f). Applying a 24% rate to what is left and Illinois's 4.95% on top, the total lands near $32,800, or roughly 41% of the profit. (Applying one marginal rate to the whole profit is a simplification; your real federal number depends on where the profit sits in the bracket table and on the rest of your return.) The same $80,000 as long-term capital gain for an investor would run roughly 15% federal plus 4.95% Illinois, or about $15,960. The dealer classification costs something on the order of $16,800 more on the same dollar amount. One threshold point that gets skipped: SE tax only applies if the activity is a trade or business in the first place. A genuine one-off investment sale produces capital gain and no SE tax at all, which is exactly what the dealer-versus-investor fight is about.
The Dealer vs. Investor Test
The IRS does not have a bright-line rule for when you cross from "investor" to "dealer." Courts have developed a multi-factor test over decades of litigation, and the factors vary by circuit. The factors most often quoted come from Biedenharn Realty Co. v. United States, 526 F.2d 409 (5th Cir. 1976) (en banc), and the cases that followed it. Biedenharn is a Fifth Circuit decision, so it does not bind an Illinois taxpayer, who sits in the Seventh Circuit. It is cited widely outside the Fifth Circuit, and it remains the clearest statement of what the IRS actually weighs, which is why I use its framework here.
The factor that carries the most weight in practice is frequency and continuity of sales. A landlord who sells one property every few years after renting it for a decade is clearly an investor. A person who buys, rehabs, and sells four houses in a single year is almost certainly a dealer. The gray area is the person who does two flips a year while holding a rental portfolio. I've seen the IRS go after those hybrid investors, and the outcome depends heavily on how the returns were filed and how the properties were held.
One strategy I use with clients who do both is holding the rental properties in one LLC and the flip properties in a separate entity. The IRS can still look through the entities to your overall activity, but having separate books, separate bank accounts, and separate returns makes it harder for the IRS to argue that all of your properties are dealer inventory. It is not bulletproof, but it demonstrates intent, and intent is what the factors are measuring.
Tax Brackets for Real Estate Income
Knowing your bracket matters because it determines how much of your rental net income or flip profit you actually keep. Illinois has a flat 4.95% state income tax, which simplifies the state side. The federal side is progressive.
Most of the landlords I work with in the DuPage and Cook County area have combined household income (W-2 plus rental) landing in the 22% or 24% bracket. Add the Illinois 4.95% flat rate, and your marginal rate on rental income held in a single-member LLC is roughly 27% to 29%. Hold it in a multi-member LLC taxed as a partnership and the 1.5% replacement tax pushes that to roughly 28% to 30%. For a flipper in the same bracket who also owes SE tax on 92.35% of the profit, the combined marginal rate runs into the low 40s.
One detail that catches people off guard: your real estate income stacks on top of your W-2 income. If you earn $85,000 from your day job, you're already in the 22% bracket. Your first dollar of rental income or flip profit starts at 22%, and additional income pushes you into higher brackets. I've had clients shocked by a tax bill on a $120,000 flip profit because they forgot it was being taxed on top of their $90,000 salary, pushing a significant chunk into the 32% bracket.
Property Management Expenses and Net Operating Income
Every dollar you can legitimately deduct from your gross rental income reduces your taxable income dollar-for-dollar. Your CPA handles the return, but you need to understand what counts because you are the one tracking expenses and keeping receipts throughout the year.
Property taxes are the expense line most Chicago owners underestimate. They deduct it and stop thinking about it. A 2026 UIC study found that TIF districts alone added about $878 to a typical Chicago tax bill in a single year, and the effect grew every year for a decade. Deducting an expense is not the same as controlling it.
Two items from that grid trip up landlords regularly. The first is the repair vs. improvement distinction. Replacing a broken faucet is a repair, deductible in full the year you pay for it. Replacing every fixture in a bathroom during a remodel is an improvement, capitalized and depreciated over 27.5 years. The IRS issued extensive guidance in the tangible property regulations (Treas. Reg. 1.263(a)-3), and the test comes down to whether the work adapts, betters, or restores a "unit of property." Your CPA needs the detail on what was done, not just the total dollar amount on the invoice.
The second is the $750,000 mortgage interest cap. That cap applies to your personal residence. It does not apply to investment property. Mortgage interest on rental property held in your LLC is deductible against rental income on Schedule E without any personal-residence cap. It is not literally uncapped, since interest on a rental trade or business is business interest subject to the Section 163(j) limitation, but most landlords at this scale fall under the small-business gross receipts exception in Section 163(j)(3). Same with property taxes. The SALT cap on itemized deductions does not apply to investment properties. That cap is $40,400 for 2026 under IRC 164(b)(7). IRC 164(b)(6) exempts taxes paid in a trade or business or a section 212 activity. I've had clients leave thousands in deductions on the table because they assumed the personal residence limits applied to their rentals. They do not.
Unpaid Rent: Cash vs. Accrual Basis
A tenant owes you $2,000 for March. March passes. April passes. You never collect. Do you owe income tax on that $2,000?
The answer depends on your accounting method, and almost every individual landlord I work with uses the cash method.
Under the cash method, you report rental income when you actually receive it. If the tenant never pays, you never report the income, and you owe no tax on it. You do not need to take a bad debt deduction because you never included the amount in income in the first place.
Under the accrual method, you report rental income when it is earned, regardless of when (or whether) you collect it. March's rent is March income even if the check never arrives. If the tenant ultimately doesn't pay, you take a bad debt deduction under IRC Section 166 to offset the income you already reported. This creates extra paperwork and timing headaches.
The cash method is almost always better for individual landlords. If you use a property management company, check which method they report on your 1099. Some management companies report on accrual basis, which can create a mismatch with your personal cash-basis reporting. I've seen this cause problems during audits when the 1099 from the management company shows income the landlord never received.
What Is Your Entity Structure Costing You?
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Entity Structuring for Real Estate: Your Options
- S-Corp for rental income: payroll cost, no tax saved
- Flip income misclassified: IRS penalties
- Hybrid investor with no entity separation: audit risk
- Over a career: hundreds of thousands in unnecessary tax
- Entity structure matched to your actual activity
- Rental vs. flip classification reviewed
- Operating agreement with correct tax elections
- Hybrid investor? Separate entities for each activity
- Tax classification guidance
- Can't form the LLC or draft the OA
- Can't transfer deeds or review title
- You still need a separate attorney
What this costs without an attorney:
A flipper who nets $80,000 as a dealer pays about $32,800 in federal and Illinois tax. That is roughly 41% of the profit. The same $80,000 held as a rental investor pays capital gains rates. Over a career, the difference runs into the hundreds of thousands.
What this costs with us:
$750 LLC formation with tax structure review included. I match the entity to your actual activity so the IRS classification works in your favor.
Your Entity Structure Is a Tax Decision
I'll review your portfolio, confirm the right LLC structure for your tax situation, and make sure your entity isn't costing you more than it should.
1099-S, FIRPTA, and LLC Sales
When you sell real estate through an LLC, two federal reporting forms come into play that individual homeowners rarely think about. If you are flipping through an LLC, you will deal with both of these on every transaction.
Form 1099-S: Proceeds from Real Estate Transactions
The title company or closing attorney is required to file Form 1099-S reporting the gross proceeds of every real estate sale. This form goes to the IRS. It reports the sale price, the date, and the seller's taxpayer identification number. For an LLC sale, the TIN reported is the LLC's EIN, not your Social Security number.
The IRS matches every 1099-S against filed returns. If the 1099-S shows your LLC sold a property for $340,000 and your tax return doesn't report a corresponding sale, the IRS sends an automatic notice. This is not a maybe. It is an automated matching program. Flippers who sell multiple properties per year through LLCs generate multiple 1099-S forms, and every one of them must tie to the return.
FIRPTA, Section 1446, and Foreign Members
FIRPTA, IRC Section 1445(a), requires the buyer to deduct and withhold 15% of the amount realized when a foreign person disposes of a U.S. real property interest. The definition does more work than the rate. Section 1445(f)(3) defines a foreign person as any person other than a U.S. person, and a domestic multi-member Illinois LLC is itself a U.S. person. When your Illinois LLC is the seller, the LLC is the transferor. It furnishes the non-foreign affidavit described in Section 1445(b)(2), and the withholding at closing is zero, even if one of its members is a Canadian. There is no version of that deal in which a title company withholds 15% of the gross price because a minority member is foreign.
A foreign member is still a live issue, just a different one. IRC Section 1446 taxes a foreign partner's allocable share of the partnership's effectively connected taxable income, and Treasury Regulation 1.1446-3(c)(2) provides that "a domestic partnership that is otherwise subject to the withholding requirements of sections 1445 and 1446 will be subject to the payment and reporting requirements of section 1446 only and not section 1445(e)(1)." Three consequences people get backwards at the closing table. The withholding agent is the LLC, not the title company or the buyer. The payments run quarterly on Forms 8813, 8804 and 8805, not out of the closing proceeds. And the base is the foreign partner's share of the gain, not the gross sale price. Section 1446(b)(2) sets the rate at the highest rate specified in Section 1 for a foreign partner that is not a corporation and the highest Section 11(b) corporate rate for one that is, so the dollar figure turns on the partner's status and the rate in effect that year. Run it with your CPA before you sign a contract, and do not let anyone quote you a number off the gross price.
The 15%-of-gross rule does apply in one structure, and it is the structure this page exists to distinguish: a single-member LLC owned by a foreign person is disregarded, so the foreign owner is the transferor and Section 1445(a) hits the amount realized. If that is your situation, the withholding can be reduced or eliminated by filing IRS Form 8288-B for a withholding certificate before closing. Section 1445(c)(3)(B) requires the Secretary to act on the request within 90 days, so it takes advance planning.
FinCEN Beneficial Ownership Reporting: Where It Actually Stands
The Corporate Transparency Act was written to make most LLCs file Beneficial Ownership Information reports with FinCEN, the Financial Crimes Enforcement Network. That is not the rule that applies to an Illinois LLC today. FinCEN's interim final rule published March 26, 2025 at 90 Fed. Reg. 13688 rewrote the definition of "reporting company" to reach only entities "formed under the law of a foreign country" and registered to do business in a State or tribal jurisdiction, and it added an exemption for entities created by a filing with a secretary of state under the law of a State or Indian tribe. In plain terms: if your LLC was formed in Illinois, you owe no federal FinCEN BOI filing. An entity formed abroad and registered to do business here still reports.
This is an interim final rule, which means it can change. Before you rely on it for a new entity, check FinCEN's current guidance at fincen.gov/boi. Note also that this covers the federal filing only. Some states run their own beneficial-ownership or landlord-disclosure regimes, and Chicago requires landlords to identify an owner and an agent for service in writing at the start of a tenancy.
What this changes practically: for an Illinois-formed LLC, BOI is one compliance item you can take off the list, alongside the ones that remain, like maintaining a registered agent and filing your annual report. What it does not change is 1099-S matching, which runs independently of anything FinCEN does. Every closing generates a 1099-S with the LLC's EIN and the sale price, and the IRS matches those against filed returns automatically. A flipper selling three properties through three separate LLCs generates three 1099-S forms, and every one of them has to tie to a return.
So the enforcement pressure on flippers is real, but it comes from information reporting the IRS has had for decades, not from a beneficial-ownership database that, for domestic LLCs, is not being populated. Anonymity was never much of a tax shield anyway: the EIN on the 1099-S leads back to a return. If you are flipping through LLCs, your returns need to be airtight for that reason.
Selling a Rental: Depreciation Recapture
Every dollar of depreciation lowers your basis under IRC 1016(a)(2). When you sell, the gain includes those dollars.
The part of the gain that matches depreciation on the building is "unrecaptured section 1250 gain." IRC 1(h)(1)(E) taxes it at a rate of up to 25%. The rest of a long-term gain gets the regular 0%, 15%, or 20% capital gains rates.
Use the example from the depreciation section. After ten full years, you deducted about $109,091. Your adjusted basis is now $290,909. Sell for $500,000, and the gain is $209,091 before selling costs.
Illustration. The depreciation portion is taxed at up to 25%. The appreciation is taxed at 0%, 15%, or 20%. Selling costs, improvements, and the 3.8% NIIT are left out.
Parts from a cost segregation study recapture differently. Appliances and carpeting are personal property. IRC 1245(a) treats gain on them, up to the depreciation taken, as ordinary income.
Two rules can push the bill out:
- A 1031 exchange. A fully deferred exchange postpones the whole gain, depreciation included. IRC 1031(d) gives the replacement property your old basis, so the deferred gain moves with it. See the 1031 section below.
- Holding until death. IRC 1014(a)(1) gives your heirs a basis equal to fair market value at your death. The gain built up during your life, depreciation included, is not taxed to them as income.
1031 Exchanges: Deferring the Capital Gain
A 1031 exchange lets you sell an investment property and reinvest the proceeds into a "like-kind" replacement property without paying capital gains tax on the sale. The gain is deferred, not eliminated. You will owe tax when you eventually sell the replacement property (unless you do another 1031 exchange, and so on).
The critical rule that connects back to everything on this page: dealer property does not qualify for a 1031 exchange. IRC Section 1031(a)(1) allows nonrecognition only for property "held for productive use in a trade or business or for investment," and Section 1031(a)(2) provides that the subsection "shall not apply to any exchange of real property held primarily for sale." Property held primarily for sale to customers, which is dealer property, is explicitly excluded. Two other limits worth knowing since the 2017 amendments: Section 1031 now reaches real property only, and Section 1031(h) provides that real property inside and outside the United States are not of like kind. If the IRS classifies you as a dealer, your flip properties cannot be exchanged tax-free. The gain is taxable at ordinary rates plus SE tax in the year of sale, with no deferral available.
For rental property investors, 1031 exchanges are one of the most powerful tax planning tools in real estate. You can sell a $400,000 rental with $150,000 in gain, roll it into a $600,000 replacement property, and defer the entire $150,000 gain. You have 45 days from the date you transfer the relinquished property to identify replacements, and 180 days to close. Read the second deadline carefully, because Section 1031(a)(3)(B) caps it: the replacement must be received by the earlier of 180 days after the transfer or "the due date (determined with regard to extension) for the transferor's return" for the year of the transfer. Sell in November and your 180 days quietly becomes about 150 unless you file an extension. That is the single most common way a year-end exchange blows up. I've walked clients through the mechanics of this dozens of times, and I cover the full process, the deadlines, and the common mistakes in my 1031 exchange guide.
$750 LLC Formation. Tax Structure Included.
I'll form the LLC, draft the operating agreement, and make sure your entity structure matches your tax situation. Rental investors and flippers need different setups.
Thank you Justin for taking your valuable time to go over the steps of a quit claim deed with me, and also educating me on the swiftest way to incorporate the process and save money! You are the best!
Frequently Asked Questions
A CPA who misclassifies your flip income as capital gains can cost you tens of thousands in penalties when the IRS reclassifies you as a dealer. My $750 LLC formation includes a tax structure review, so your entity matches your actual investment activity from day one. Pay what you owe and nothing more.
Further Reading
External resources: IRC Section 1402 (Self-Employment Tax) · IRC Section 1031 (Like-Kind Exchanges) · IRC Section 1411 (Net Investment Income Tax) · IRC Section 168 (Depreciation) · IRC Section 469 (Passive Activity Losses) · IRC Section 199A (QBI Deduction) · Rev. Proc. 2019-38 · IRS Publication 527 · IRS Publication 925 · 35 ILCS 5/201 (Illinois Income Tax Rates) · FinCEN: Beneficial Ownership Information
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