California Resident With Wisconsin Real Estate: Where Does He Pay Tax?


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2 Comments

I received a question at US Tax Aid that is applicable to a lot of people, whether they know it or not. In fact, this is a thing that people get wrong. I’m really happy to get this question. Here is what we received at US Tax Aid.

We reside in California. My wife and I plan to form a Wisconsin LLC prior to closing the purchase of a Wisconsin multi-family property. We will hire a Wisconsin property management firm and likely an on-site manager. I suspect that the Wisconsin LLC will be a disregarded entity on our Federal return, with losses flowing to Schedule E. In this situation, will we be obligated to file a California LLC return and pay the $800 minimum state tax? If so, could this be structured to avoid the California tax?

And my answer:

Normally, we consider nexus (connection) with businesses and real estate. That is no exception in your case, although it’s a little different. For asset protection, you will probably want a WI LLC. You could hold it in your own name, but then you lose the protection of an LLC. If you held it in a CA LLC, you wouldn’t have a standing for any legal action. For example, you couldn’t evict a non-paying tenant. The only way you could do that is to also have it authorized in WI. It’s probably easier to just have a WI LLC.

And now we have the CA issue. California has taken the position that if you live in California and have an LLC in any other state, you must be doing some kind of work in California. That’s their position even if you have a property manager. And for that reason, they want you to also pay the $800 annual fee to them, even if you don’t have a CA LLC. You just have a WI LLC.

Plus, if there is gain, you’ll pay tax in WI. You also have to pay tax in CA because the profit will flow through to your personal tax return, which shows you as a California resident. You will receive a tax credit for the WI tax you pay. So you don’t really have double tax on the income, but you do need to file both a WI return and the CA return.

Unfortunately, there really isn’t a strategy to fix this other than moving outside the state of California. No other state is this rough on residents who invest outside the state.



2 Comments

  1. Diane Kennedy says:

    It wouldn’t be taxable, because it’s held within a pension. Later, when it’s distributed if the owner is still a CA resident, the pension distributions would be subject to California tax.

    As far as the $800 minimum payment, a case in 2017 determined:

    “Under the standard developed in “Swart”, California cannot automatically impose the minimum tax on members of LLCs that do business in California through the attribution theory. The court established a four-part test, that if met, will relieve members of the $800 minimum tax. The test is as follows:

    The member has no interest in the specific assets of the LLC
    The member has no liability for the obligations of the LLC
    The member has no ability to act on behalf of or bind the LLC
    The member has no right to participate in the management or control of the LLC”

    The “doing business in California” noted above is a bit misleading. If a member/partner, even a 0.2% limited partner in a recent case, is doing one of the above four items, the LLC is doing business in California.

  2. Amy says:

    Thanks for answering this question.

    What if the property is held in self directed IRA and managed by WI property manager? The owner of the IRA LLC lives in CA but really is just a passive investor.

    Or take it even further, what if a CA resident partner up with a friend in WI, set up a LLC in WI and bught a rental property. CA resident used his IRA money for investment.

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