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-Corp or C-Corp), 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-Corp.
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. Read this link if you own a single member LLC.
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-Corp 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, an 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.
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Fulton Abraham Sanchez, the founder of FAS CPA & Consultants of Miami, FL, is a Certified Public Accountant specialized in Offshore Banking Consulting. You can email him to email@example.com.
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