Llc Vs S Corporation For Rental Properties
An S corporation is a business model that elects to use a pass-through taxation method. The shareholders are responsible for reporting their own corporate income, deductions, and losses. This alternative is most similar to an LLC because of tax similarities and liability protection.
There are some differences, as well as benefits for choosing an S corporation over an LLC.
- Self-employment taxation. When your LLC is taxed as a sole proprietorship , members still have to pay a self-employment tax. With an S corporation, owners are allowed a reasonable salary. Any corporate earnings over this salary amount are considered unearned and wont be subject to the self-employment tax. This is one of the most important benefits to choosing an S corporation.
- Good for multiple owners. S corporations can prove beneficial for multiple owners overall, though there are some limits to how many members or shareholders an S corp can have. The business model works better for multiple people than an LLC, because there is a clear hierarchy with leaders and managers.
On the other hand, some drawbacks may apply.
- Fewer members. An S corporation cannot have more than 100 shareholders at any time. LLCs can have as many members as they want or need to have, and their numbers arent regulated.
- Citizenship. For someone to be a shareholder in an S corporation, they must be a US citizen or a US resident. This is not the case with LLC members.
What Are The Pros And Cons Of Creating An Llc
- LLCs limit your personal liability, which potentially saves you a lot of money.
- They separate and protect each of your rental properties.
- You get the benefit of pass-through taxation, so your income is not taxed more than once.
- You can easily separate business expenses from personal expenses by having a separate bank account for your LLC.
- Its a headache to do the additional paperwork.
- Its potentially more difficult to qualify for a mortgage as an LLC and youll possibly have a higher interest rate.
- LLCs have annual filings that can be expensive .
Despite the additional work and costs, the protection LLCs provide is often worth it for landlords.
Personal Assets May Be Leased To The Llc
If a valuable assets drag you into a higher tax bracket, an LLC offers a handysolution. You may be able to minimize this situation by leasing the asset to yourself with a formal leasing agreement. Such arrangements lower taxable income and often allow for deductions.
For example, a home office is an item you lean on come Tax Season when youre deduction hunting. Learn more details about the home office deduction and who can qualify from our previous educational resource on the subject. Home offices may not only be deducted from your taxes, but also leased back to your LLC. When that leasing agreement goes through, you can write it off and claim it as a business expense. The fact that this type of business expense
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Costs Incurred While Looking For New Property
The costs of hotel, airfare, rental car, meals, and other travel expenses incurred while looking for a new rental property are fully tax-deductible if they are ordinary and necessary.
To qualify, at least half of the time spent away on travel must be spent on doing business, and the primary reason for travel must be business. This means investors can get a tax break for a long weekend in Florida as long as they spend the majority of time engaging in business-related activities.
An Llc May Be Taxed In Four Primary Ways:
- As a sole proprietorship
- As a C corporation
- As an S corporation
If you own a single-member LLC, you may elect to be taxed as a sole proprietorship, partnership, or C corp. If your LLC has more than one owner, a sole proprietorship isn’t an option, but the remaining three are.
Here are some factors to consider when deciding how you want your LLC to be taxed.
Once making your decision on tax status, your next step is more paperwork. That is, if you want your LLC to be taxed as anything but a sole proprietorship, you must file Form 8832 to inform the IRS of your LLC’s partnership or corporation status.
For most small business owners, structuring a business as an LLC offers the most versatility in determining how the business is taxed, while also offering the limited liability of a corporation but with less formality. Because every LLC is unique, you may wish to obtain solid legal advice before moving forward on tax status selection.
About the Author
Michelle Kaminsky, J.D.
Freelance writer and editor Michelle Kaminsky, Esq. has been working with LegalZoom since 2004. She earned a Juris DoctoRead more
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Tax Considerations For An Llc
When deciding how you want your LLC to be taxed, its important to consider all of your possibilities in order to make an informed decision. The right tax method for you might change based on what your biggest need is and how that need is treated for taxes. Here are the most important tax considerations when you form an LLC:
Llc Vs C Corporation For Rental Properties
C corporations are the standard business model . This means its the business type widely used for most larger companies and retailers. This is the type of company that is heavily taxed, but there are divisive benefits to choosing this business model over an LLC.
A C corporation is beneficial in the following ways.
- Lower audit risk. LLCs and sole proprietorships are much more likely to be audited, because they are in the hands of one or more property owners who must keep their own records. Due to the nature of a C corporation, its less likely to be audited.
- Business debt liability. The liability of a C corporation is a bit more than an LLC covers. Here, there is some measure of business debt liability as well as general liability. It provides more protection for your personal assets.
- Great for bigger incomes. If you have a lot of rental income or plan on expanding your business, a C corporation is a good option despite the tax issues because of the way it handles shareholders and investments.
However, there are substantial drawbacks that LLCs help mitigate.
C corporations are not set up to be a single-member or single-owner business. Multiple owners or owners with multiple properties may get some benefit from a C corporation, but overall it isnt ideal for the average landlord.
Depreciate Costs Over Time
Depreciation is the incremental loss of an assets value, generally due to assumed wear and tear. As a real estate investor that holds income-producing rental property, you can deduct depreciation as an expense on your taxes. That means youll lower your taxable income and possibly reduce your tax liability.
Youre allowed to take the depreciation deduction for the entire expected life of a property .
For instance, maybe you purchase a home you intend to rent out. The value of the building itself is $300,000. If you divide that value by the 27.5 year expected life of the dwelling, you can deduct $10,909 in depreciation each year.
Once you sell, though, be prepared to pay the standard income tax rate on the depreciation youve claimed. This requirement is known as depreciation recapture, which you can avoid if you pursue other tax strategies, like a 1031 exchange .
Pro tip: Ask your accountant about depreciating major improvements youve made to your investment properties, such as installing a new roof.
The Tax Benefits Of An Llc For Rental Property
A Limited Liability Corporation or LLC is a popular business structure for real estate investors because it offers flexibility, legal protection, and tax advantages. But you have to know how to properly set up and maintain your business to reap the rewards. Here is a look at a few benefits of llc for rental property owners, along with some of the disadvantages.
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Multiple Real Estate Llcs
We have already discussed the advantages of using an LLC to purchase and sell real estate investments. It can also be advantageous to have one LLC own another LLC. When an LLC owns another LLC, it is called the parent LLC. The LLC being owned is referred to as the child LLC.
Example Scenario: Mykayla owns Pacific Real Estate LLC. She wants to purchase a rental property owned by Bobs LLC. Bob and Mykayla agree that instead of buying the property, Pacific Real Estate LLC will purchase Bobs LLC and thus take control of the rental property. Now Pacific Real Estate LLC is the parent LLC, and Bobs LLC is the child LLC.
A parent LLC can have multiple child LLCs. For serious real estate investors it may be advantageous to have a separate child LLC for each real estate property. If a child LLC gets sued, it can only be sued for the assets in the child LLC. Any of its earnings already transferred to the parent LLCs would not be at risk.
Limiting Liability In The Event Of A Lawsuit
Limiting liability in the event of a legal dispute can be tricky. Courts can either enforce or invalidate such clauses, and its always a good idea to seek local legal advice. One important thing to consider when drafting a limitation of liability clause is the nature of the claim. Some actions may be barred by statute, while others may be barred only by contractual provisions.
Another way to limit liability is to agree on a damage cap. This limit would limit the amount of money one party would be liable to pay for damages if the other party won the suit. For instance, if party A causes damages to party B, he would only have to pay the damages up to a cap and then be responsible for anything above that amount.
Limiting liability in the event of a legal dispute should be drafted carefully. It should include clear standards for what constitutes misconduct. An example would be gross negligence. If the customer wants to exclude certain behaviors, they should explain the misconduct in the contract. Whether the customer can prove, negligence is an important consideration.
A court can impose a limit on liability that is both clear and reasonable. It can even impose a sole remedy clause that limits the plaintiffs rights to return the loan. However, using a sole remedy clause can make the litigation more expensive for both sides.
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Are There Ongoing Costs Once You Create An Llc
Below are two possible ongoing costs once you create an LLC:
- Annual franchise tax can be $250-800.
- Most states charge an annual fee for having an LLC. It can be as low as $9 and as high as $500.
In addition to the above costs, there is the possibility that your interest rate will change as a result of transferring title of your property .
Keep in mind that transferring ownership to your LLC may trigger tax consequences depending on the value of your property when you transfer title. This is because the value of your property may have increased from the time you bought the property. These additional tax consequences can be avoided by creating an LLC before you buy the property.
Legal Compliance & Taxes
Reviewed by Mynd Editorial Staff
Owning rental property has its share of challenges, but there are some serious tax advantages that can make it worthwhile. Surprisingly, some owners fail to take full advantage of these tax benefits when filing their returns.
Most write off costs like mortgage interest, insurance, and ordinary maintenance and repairs understandably, as these are widely known. But there are many other tax deductions that rental property owners should take advantage of.
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Reasons To Hold Your Real Estate In An Llc
As a New York real estate attorney and investor, I am asked Should I hold my real estate investment or rental property in a Limited Liability Company ? Yes, you should be putting your real estate in an LLC.
Anyone researching this may run into terms like rental property or investment property, which are usually referring to any property you dont plan on inhabiting yourself. And a huge mistake real estate investors make is failing to separate their real estate investments with an LLC. We live in an incredibly litigious society, so protecting yourself is a major key to success.
Limited liability companies provide tax benefits, anonymity, easy title transfer, and personal liability protection when it comes to holding real estate.
Easier To Invest With Partners
The LLC structure makes it easier to invest with friends or business partners even other investors who dont know the LLCs principal owner.
For example, two people can launch an LLC as partners. A second member can simply join a single-member LLC and create a multiple-member LLC.
You can also easily sell LLC shares. The easiest way to handle this involves having an existing partner sell their shares to a new member. Members must distribute 100% of the shares of an LLC.
Note: This does not mean that unrelated persons interested in buying a home together should consider the LLC structure. Without a true business purpose, the structure will not be considered legal.
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Options To Avoid Capital Gains Taxes Entirely
Not every tax bill is inescapable. If you plan carefully, you can avoid capital gains taxes in some cases.
Death, Not Taxes
The simplest strategy is to avoid selling your income-producing assets.
You get to keep collecting passive income from these investments through your working and retirement years. When you die, the assets go into your estate. The capital gains taxes then become your heirs problem.
But it doesnt always work like that. First, the cost basis for your assets typically resets upon your death. In the world of accounting, your cost basis is the amount you paid for an asset. Its used as the baseline to determine your capital gains later.
Say you bought a property for $100,000, and the day you die, its worth $1 million. If youd sold it while still alive, the cost basis would be $100,000 and youd owe capital gains taxes on a $900,000 profit. After you die, the cost basis for tax purposes jumps to $1 million. So if your heirs sold it at that price, they wouldnt owe any capital gains on it.
In fact, most estates dont end up owing any federal estate taxes. In tax year 2021, the first $11.7 million in an estate is tax-free on the federal level, though some states impose their own estate taxes, even on smaller estates.
You also have options to pull equity from your property before you die.
Cash Out Your Equity With Loans
Perhaps you start looking at all the equity in a $1 million property you own and start seeing dollar signs. You want to spend some of it.
Protects From Personal Liability
Holding each investment property in its own LLC limits owner liability that is owed to any tenant, guest, invitee, trespasser, or random person walking by to the value of that specific investment.
When you create an LLC, you are creating a separate entity from yourself. You may own the LLC, but the LLC does not own you or your personal assets. When LLCs own a property, the owner of those LLCs are removed from any liability. So barring any serious misconduct on your end, the LLC is responsible for any debt or lawsuits that are charged against the property.
For example, you own three different investment properties. Each property is held in its own separate LLC. A person walking in front of one of your properties falls over a raised sidewalk and breaks their hip causing the need for several surgeries. The injured party sues the property owner for negligence and other claims. In this scenario, if the property is held by an LLC, the liability is limited to the value of that property, and only that LLC will be named in the lawsuit.
If the property was not held in a separate LLC, the owner/landlord will be named in the lawsuit personally and the landlords/owners personal assets could be seized to satisfy a judgement. That means personal any bank accounts, vacation property, and personal items could be seized.
To learn more about liability protection through an LLC, you can always contact our office at or you can contact us to pick a time to speak with an attorney.
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Learn Why A Llc Is A Popular Business Structure For Real Estate Companies
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A limited liability company is a popular business structure for real estate companies involved in the business of buying, selling, or renting commercial or residential real estate. Most real estate company owners want to make sure they take appropriate steps to limit their liability because of the numerous risks involved with running a real estate business. These risks include depreciation in the value of property, lawsuits arising out of construction accidents, and issues with tenants. One way to reduce the risk of personal liability is to create a separate entity for your business like an LLC.
Real Estate Tax Benefits To Take Advantage Of
Buying traditional or Airbnb investment property is one of the best ways of growing your wealth. Owning real estate allows you to create a passive income, build equity, hedge against inflation, leverage funds, build generational wealth, and be your own boss. And theres another major advantage: real estate tax benefits.
If you own real estate and youre not aware of all the tax advantages available to you, then youre missing out on different ways to save money.
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