How To Select The Best Entity For Your Real Estate Investments

FAS CPA & Consultants

It´s about The Entity!

The most important question for real estate investors: is my current business entity tax optimal, or can I do better?

Large businesses operating as C-Corps got a considerable reduction in their tax rates – down from 35% to 21%, but small businesses have a wealth of new options to reduce tax liability too.

Opting for the Best Entity

  1. The Trump Tax Reform or  TCJA provides significant tax advantages for S-Corps and LLCs but for C-Corps that are collecting large profits earmarked for debt repayments or capital expenditures the new Act provides for the retention of more profits on an after-tax basis than it does for S corps or LLCs.
  1. For owners planning to sell a business, a C-Corps provides a ‘qualified small business stock provision’ that allows them to exclude 100% of their gain from income taxes.
  1. Nevertheless, apart from advantages like those mentioned above, the majority of benefits created by the Act are for S-Corps. Now is the time to consider opting for S-Corps status.
  2. For Rental Income Investment, go for a LLC.
  3. For Flipping, go for a C-Corps.
  4. For Construction, go for a S-Corps as well as for Real Estate Management.
  5. For Asset Protection, put each property on a separate LLC or create a Land Trust for each property as beneficiary of the LLC if all properties are consolidated into a single LLC.

Section 199A

  1. Section 199A creates the possibility to deduct qualified business income (QBI).
  1. This offers substantial savings for business owners, but companies that wish to benefit must carefully assess how to capture this opportunity.

Your tax preparer must be instructed to assess every opportunity. This means they have to evaluate every entity and every business segment in every entity meticulously to develop specific guidelines for you.

Maximizing Tax Deductions

  1. Small businesses that turnover sales of less than $25,000,000 can also benefit by electing an accounting method that changes them from accrual to cash basis accounting. This provides a one-time tax windfall with many other planning opportunities afterward.
  1. Tax-smart income planning is crucial in terms of the new law.
  1. Doctors and lawyers and other service providers must do everything in their power to keep their owner’s taxable income BELOW $415,000 and as close to $315,000 as possible.


Service Business Owner A has a taxable income before contributions of $415,000.  Owner A now makes a $100,000 contribution to a cash balance defined benefit plan. This lowers Owner A’s taxable income to $315,000, saving him approx. $50,000 in tax, depending on which state he operates in.

Plan Ahead

  1. It is always “tax planning season.” For tax purposes, a five-year tax projection is essential to allow forward strategizing and tax planning that includes:
    • Grouping charitable contributions,
    • Harvesting capital gains in a lower tax year
    • Opening a donor-advised fund
    • Using a charitable trust
  1. Early consultation with tax advisors can enable small businesses to plan for when they become high-net-worth operations and complicated tax, and estate rules make it difficult to transfer or pass wealth to family members or to sell the enterprise.
  2. High-net-worth taxpayers have a window of opportunity NOW while the higher estate tax exemption makes it possible for them to save substantial estate tax by gifting assets to family members, at discounted rates, into a family trust or LLC.

Big or Small, Tax Planning for All

Tax strategies deployed by qualified advisers can minimize your tax liabilities even if you own a small business.  Those who understand tax law and financial planning can allow even the most modest business to benefit from the rules created by the Tax Cuts and Jobs Act of 2017.

When you decide into the business of real estate investing, you have to spend some time thinking about whether to manage your property business as an individual or incorporate it. While both options have their positive and negative sides, you will generally be advised to register your real estate investment business as either a Limited Liability Corporation (LLC) or a Corporation (S-Corps or C-Corps), depending on the activity, rental or flipping. There are two main reasons for you to follow this advice – protecting your property and personal finances against lawsuits and minimizing the amount of taxes you pay. So here comes the next question: which is better, an LLC or an S-Corps.

Advantages of LLC

Often people don’t want to incorporate small businesses because they feel overwhelmed by the amount and complexity of paperwork required by law. In reality, however, when you decide to register your real estate investment business into a limited liability corporation you wouldn’t have to stress yourself with too much paperwork, which is also relatively easy and in most states, you are now able to do everything online. Also, the fees for registration and maintenance of an LLC are much lower than those applicable to S-Corps and C-Corps. It is a suitable option for sole owners, who want to get legal protection for liabilities. The level and rules of taxation for LLCs are different and less daunting than corporate taxes. Generally, this type of organization provides the owner with a lot of flexibility, which used wisely is a major advantage. Although in Florida an LLC need at least two partners to exercise the limited liability protection. 

Disadvantages of LLC

It is exactly the high level of flexibility that LLCs offer that sometimes creates big problems for owners. The main reason is the complexity of having to follow all the rules when there are numerous paths one can take for various business purposes with a limited liability corporation. For example, if there are only one owner/manager and no members, the business is taxed as a sole proprietorship and if the LLC has a manager and members, then it may be taxed as a pass-through entity. In the case of the latter, the members will be taxed on all profits as though it is their income, which can be quite inconvenient for many.
Another disadvantage is that sometimes deductions from capital gains for corporations are less significant than those for individuals because of the different taxation rules. In cases where you made a big profit, this could play an important role of how much money you can keep for yourself and how big part of the pie you will have to send to the IRS.

Advantages of Corporations

C-Corps are particularly good for people who buy properties to exchange and do not want to wait a year before they can flip the existing property with a new one. Also, such structure is very advantageous for investors who buy real estate in a not very good condition and renovate it or carry out repairs before they sell. This means any profit will be treated as ordinary income and the corporation will be taxed only. 
The third group of real estate investors can find incorporating their business into an S-Corps especially beneficial. Those are the people who also exercise property management activities. By hiring someone as a property manager and paying them a fair salary, the owner can benefit by getting a good retirement plan for themselves and their family.
C-corps bring another set of benefits related to access to financing. A C-Corp is much more likely to get approved for a bigger loan and even get lower interest rates because the credit history of the individuals associated with the corporation is not taken into account.
Last but not least, a S-Corp is taxed at the individual level rather than the corporate one, so to a certain extent, it could be a good solution for becoming invisible for federal income tax purposes.

Disadvantages of Corporations

The paperwork for corporations is usually quite intense and requires special attention. In many cases, you would be asked to provide annual internal documentation. For a number of people, especially those busy with another job or having a fast-paced lifestyle, dealing with something like that is a major setback. One must be well familiar with all related laws in order to keep themselves out of trouble with the IRS and the authorities. Often times, it is necessary to assign your accounts to a professional accountant to navigate you through all the required actions before, during and after the incorporation and make sure you are doing everything right. Of course, that results in more costs for you and your business.
When applying for corporate loans with an S-Corp, all of the members of the company must undergo a credit check and if their individual scores are not satisfactory this can affect the outcome of the finance application.
Probably the biggest deal breaker for C-Corps, in particular, is the double taxation that can occur in this type of organizational structure. It happens because the corporate profit is divided among shareholders in the form of dividends, which need to be reported as an income and an income tax must be applied. However, before the distribution, the company has to pay corporate tax on the profit as a whole, so that’s how double taxation occurs.
The decision whether to incorporate your real estate investment business and what type of structure in particular to choose is not to be taken lightly. There are many angles to be considered and in most cases, no matter how many articles on the pros and cons of different corporation types you read, chances are you will not be 100% convinced which is the best option for your business. The wisest thing to do would be to book a consultation with a good CPA who will surely have more insights than what you could find online and will help you pick the structure that suits you best.

What Entity Structure Is Best For Active Income vs Passive Income

What Is Passive Income?
Income that requires no effort to produce and maintain. The IRS example is income derived from property or equipment rental. In some cases, it can include royalties that are not derived from participation in a business.
For the IRS, passive income means revenue from a business in which the taxpayer does not materially participate on a regular, continuous, and substantial basis.
This includes partnerships, S Corps and individual limited partnerships where the partner does not have an active role in the daily operations of the enterprise.
Capital gains, interest and dividends are not considered passive income by the IRS.
What Is Active Income?
Also known as nonpassive income, it refers to revenue received from enterprises in which the taxpayer participates by performing a service or selling a product.
Define Participation
You work 500 hours or more in the business per annum.
You do the majority of the work in the business.
You work more than 100 hours per annum in the business, and no staff works more than this.
Examples Of  Nonpassive Income
Salaries Wages 1099 commission Guaranteed payments
Interest Dividends Stocks Bonds
Sale of undeveloped land Sale of investment property Royalties from the ordinary course of business Sole proprietorship
Farm in which taxpayer materially participates Partnership in which taxpayer materially participates S-Corp in which the taxpayer materially participates Limited Liability Company in which the taxpayer materially participates
And trust in which the fiduciary materially participates

The Impact Of Your Business

Passive income is passed through – passive income is divided up by the business (expenses too) and distributed to the shareholders in relation to their stake in the company. Passive losses are similarly distributed. The taxpayer must keep passive income and losses separate from active income and losses. A loss from passive income can only be applied to passive income.

C-Corps that switched to S-Corps are limited in how much passive income it can earn because the C-Corp previously retained earnings and profits, which it did not pass through to the shareholders and owners.

S-Corps can therefore not generate more than 25% of gross receipts from passive income in any specific tax year.  Any income derived from passive income above the 25% threshold is taxed at the highest corporate income tax rate.  If this were to happen for three consecutive years, the S-Corp will lose its status and be taxed as a C-Corp once again.

The C-Corp Under The TCJA

The 21% flat rate introduced by the TCJA lured many business owners to elect C-Corp status for their enterprises.  These taxpayers can however, also be assessed personal holding company (PHC) tax. PHC status is assessed annually and determined by two tests:

  1. Income test
  2. Ownership Test

The additional PHC tax assessment requires that at least 60% of the company’s income must derive from passive income sources AND five or fewer shareholders must hold more than 50% of the corporation’s stock.

Those who meet these requirements will be charged the PHC tax, which is 20% of the undistributed passive income. As a C-Corp, you can avoid the extra PHC tax by passing along a dividend of passive income to the shareholders.

In all other instances, passive income tax rates are determined by how long investments are held, the amount of the passive income and the tax bracket of the taxpayer.

Best Structure For U.S. Real Estate Investors In Various States


What are the benefits of having an LLC as your main structure in Real Estate in various states?

The first benefit that you get is the limited liability protection so whenever you are at risk in the company is the amount of your investment and if anything happens no one will come after you and your personal assets, that is the limited liability protection. But for that the LLC needs at least 2 individuals that the first premise, you need to take into consideration when forming an LLC.

Usually whenever you buy property in one state you are supposed to have the LLC in that state because the state only allows companies that are registered in the state to do business. So, if your strategy is to buy real estate in various states ideally you should have one LLC for each state your buy the property and then all these LLCs will pass through to a single entity that could be another LLC or an S corporation, we recommend the S corporation and that is receiving the income from all the different LLCs in all the states.

So we have a structure composed of several LLCs that go state by state and they own property in that state and then all this LLCs are flowing the profit to the S Corporations and this one is the one that flows to you personally and then you pay taxes that the ideal structure for an LLC and the benefit is the limited liability protection why we suggest this because it is not a good idea to concentrate all the assets into one single company. Let’s say you have one company in one state, and you buy in other state then you are concentrating into one single entity that is a concentration of risk that if you do not have enough umbrella insurance protection it could at one point mean that you are not covering for all the risk that you have in this bulk of properties.

What is the best to have an LLC if you’re a Real Estate investor in various states in the US?

The best state to have an LLC is the state where you buy the property in. If you buy in Colorado, you have an LLC in Colorado. But the best state is always that doesn’t charge income tax in addition of the federal income tax. Now we also have to remember that real estate whenever we have an LLC or an S corporation the LLC will not pay taxes at the state level because it’s an LLC and it means if there are 2 individuals the LLC will not be taxable at the company level because it will flow the profits to the individuals but because of the structure of the LLC the company will only pay taxes at the federal level so there is no state income tax, but remember for that to work the LLC needs to have 2 individuals. If you have an LLC with 1 single member it will be considered a disregarded entity and the courts will not recognize it as a separate entity therefore it’s like it doesn’t exist and then there is no protection for any third parties’ liability because you are not an LLC and also the IRS will not recognize it as a separate entity therefore you are taxable at the state level and the federal level.

I know that many times people say that Delaware and Wyoming are the best place to open an LLC because of taxes but it all depends on the strategy that you have. We always advise that the LLC should be opened at the state where you are planning to buy the property. There is no too much of a benefit to open a company in that state like Delaware or Wyoming because they will only give the secrecy of not revealing the name of the partners but in addition it will not be advantageous to buy property in California with an LLC formed in Delaware. But the best application of a limited liability protection strategy is to make sure that the place you invest in the place to have the company. Second if you are in a state with state income taxes you better form an LLC with 2 members that is the best structure considered to have when you are planning to open an LLC.

What is the correct way to establish an LLC for Real Estate investors in various states for the IRS to consider at the tax level?

The best way is to open an LLC in each state, once you have that and you have 2 members it doesn’t need to have a different name it could the same name in every single state and in addition you can also register the company in Texas and buy property in Minnesota then you also register the company in Minnesota and is going to give you that limited liability protection because you are formalizing your company in that state.

Now once you have that structure and have the strategy on what kind of property you want to buy now the next structure it could be another LLC but we suggest if it’s an S corporation and this will be for administration and will be the owner of the other LLCs and those are the entities that hold the real estate individually, do not concentrate in one single all the properties because it is too much of a risk and if you do have it you better a good liability insurance for protection enough for any kind of liability in real estate.

What type of tax strategy is recommended for Real Estate investors in various states in the U.S.?

The good thing about real estate is that whenever you are operating there is depreciation and when applied to the property as an expense it is usual that the company doesn’t have any profit but losses so the activity itself gives you a tax shelter and that is the depreciation of the property if its residential you depreciate it in 27.5 years or if its commercial you depreciated in 39 years it will give you a big deduction that will make the activity of the company a loss and because of that the loss will contribute to the tax return and not create any kind of taxes.

So, the activity itself of real estate if applied the depreciation it will give you a tax shelter that will shield the income of that real estate activity from taxes. Now, you have to be very careful if you plan to sell it in the future 3 to 5 years because even though the depreciation is expensed out in one year when you sell it you have to retake the depreciation so the depreciation that allowed you to pay no taxes in the year that you operated the property out, in the year you are going to sell the property the depreciation is going to be recaptured and that means profit for you and that means taxes.

We recommend not to take depreciation because that is only going to defer those taxes, the profits are only deferred so if you plan to sell it in 3 years is better not to take depreciation and at the end of the deal you don’t have to recapture that amount of depreciation that creates more taxes for you. If you plan to have separate state investment is the same strategy, even though the states deal with activities separately and each state has its own regulation and laws at the end taxes are federal it is only when you have an LLC with 1 member, and he is the one responsible for taxes. Better is for tax strategy to carry an LLC with 2 members, the same strategy for all states as the LLC is federal then you will not be subject to state income tax because you must have your LLC with 2 members, that is the most basic requirement for real estate investment using a tax shelter as a tax strategy.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intended for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services.  This article cannot serve as a substitute for such professional services or advice.  Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation.  This article is subject to change at any time and for any reason.

Check The Video Version Tax Planning for U.S. Real Estate Investors

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