If you own a multi-unit complex chances are you have an onsite property manager. Typically these arrangements consist of base pay and free rent, where the amount of pay is commensurate with the number of units and the amount of work. If living on site is a perquisite to being a property manager, then federal income taxes are not a concern for either the property owner or the manager.
As an employer you can exclude the value of free rent provided to your apartment manager provided his employment meets three conditions:
- You must furnish the lodging on the business premises, i.e., the property being managed;
- You must have a valid business reason for providing the housing, i.e., you want the manager on site to respond to tenants and protect the property; and,
- Your manager MUST accept the lodging as a condition of employment.
If any of these conditions are not met, the employer must include the net value of the lodging on the employee’s W-2 form, and the employee must report that amount as income on his tax return.
However, federal taxation is not the only governing body regulating employer provided housing. State law must also be consulted to ensure you do not run afoul of any other regulations. A recent visitor to my office, Tim, learned this lesson the hard way.
Tim acquired a 16 unit apartment complex in 2008 and placed it in a newly formed limited partnership, managed by a corporation, for asset protection. Shortly thereafter, he offered an existing tenant free rent ($600 value) in exchange for serving as his onsite property manager. The manager’s duties consisted of fielding tenant concerns and complaints and providing minor repairs. Due to the small number of units, no other compensation was provided. Within a few months of his acquisition, Tim decided to replace the building’s roof. In exchange for six months of free rent, two of Tim’s tenants, a roofers by trade, agreed to do the work and it was completed within a month.
Fast forward to 2012 and a young state auditor looking to make a name for herself audited Tim’s limited partnership and determined he owed Labor and Industries $90,000. The assessment, according to the auditor, was based on Tim’s employment of three full time employees for the past three years (the two roofers and the apartment manager). The auditor did not understand onsite manager’s duties and incorrectly assumed that the manager and the roofers worked full time on the premise.
What makes this story extremely troubling is Tim’s complex has gross rents of $100,000 a year (the L&I assessment amounts to 1/3 of his gross rent). Because of not paying workers compensation when it was due, penalties increased the $100,000 to $200,000, or 25% of his buildings fair market value. The $200,000 judgment was levied on Tim individually.
– – – – – – – – – – – – – – – – – – – – – – – – – – – –
If you have an onsite property manager it would be wise to keep a record of his hours and enter into a formal contact with the manager. The contract should specify the manager’s duties, compensation, and expected time commitment. It would be preferable to treat your manager as an independent contractor so you can avoid withholding and insurance issues. If this is not workable, then consider having your manager provide you a monthly log of his hours. You should also consider creating a property management corporation and hiring the manager through the corporation to manage your property. This would provide additional liability protection and if structured properly you may be able to avoid the imputed compensation issue addressed above for the free rent.
Owning real estate can produce great returns but small mistakes have the potential to wipe out many of these gains. If you employ a property manager I suggest you contact your state department of Labor and Industries to determine your reporting requirements. Also keep in mind some states do not permit you to provide “free rent” as the total compensation. These states treat a portion of the rent as a setoff against a minimum wage owed to the manager for his services. Best of success with your investing and here is a sample management agreement for your review. Independent Contractor Property Manager Agreement