s corp vs llc for real estate investing

Everything you need to Know about S Corporation vs. LLC for Real Estate Investing

Investing in real estate has consistently been the most successful path to financial freedom. However, it also comes with potential risks.

We are living in a controversial society. As a real estate investor, you must employ a business entity to safeguard your assets against potential losses and liabilities.

Asset protection has necessitated that many self-employed real estate investors organize their companies as a corporation or a limited liability company (LLC). The most familiar choices among real estate investors are S corporations and LLCs.

As much as S corporations and LLCs are often discussed side by side and offer a few similar benefits to real estate investors, they refer to different aspects of a business.

An LLC is a type of business entity while an S corporation is a tax classification. As a real estate investor, the type of business structure that you choose is important to the prosperity of your business.

Here is a detailed explanation of each of the business structures.

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 S corporations

An S corporation is a special tax designation created by the internal revenue service (IRS).  It refers to any business that chooses to pass corporate income, losses, deductions, and credit through shareholders for federal tax purposes with the benefit of limited liability and relief from double taxation.

Requirements of an S corporation

According to the IRS, to qualify for S corporation status, a corporation must:

  1. Be a domestic corporation.
  2. Must have not more than 100 principal shareholders.
  3. Have shareholders that are persons, estates, or trusts.
  4. Shareholders must be citizens or Permanent residents.
  5. Only have one class of stock.

S Corporation Taxation

The corporate income, loss, credit, and deductions are passed through to shareholders for tax purposes.

Income taxes are paid by shareholders on their personal tax returns. Thus it is being exempted from paying taxes at the corporate level and not subject to a corporate tax rate.

S corporations use form 1120s to file their taxes.

S Corporation Fees

  • Filing fees for the articles of incorporation. They are filed with the secretary of state (SOS). The fees usually vary by state. The filing and administrative fees usually range from $100-$250.
  • Franchise tax prepayment. The fee charged will vary by state from $800 to $1000.
  • Miscellaneous government filing fees. The fee varies from $50 to $200 depending on the state and type of business.
  • Lawyer’s fees. Law firms offer flat fees between $ 500 to $700.

 The procedure of forming an S corporation

  1. Choose a name that does not already exist.
  2. Establish and name the body of directors. They act as the governing body representing shareholders.
  3. File articles of organization with both the IRS and the local office of the secretary of state.
  4. File the corporate bylaws with the local secretary of state office.
  5. File Form 2553 with the IRS. The form is called the Election by a Small Business Corporation, which makes the company official with the Internal Revenue Service.
  6. File with a registered agent. 

Pros of an S corporation

  1. Asset protection. Should unforeseen circumstances arise, you need protection from personal liability for the business debts. Corporations separate corporate shareholders’ assets from corporate assets.
  2. Pass-through taxation. S corporations help alleviate some of the self-employment taxes. This is because as a real estate investor you have the advantage of classifying money partly as income and partly as a distribution.
  3. Once an S corporation is established its existence is continuous, unlike an LLC where the departure of a member may result in the dissolution.

Cons of an S corporation

  1. Unlike in LLC, in S Corporation subdividing of property with the same tax benefits, is not possible. Subdivided transfers are taxed based on the appraised transfer of assets.
  2. S corporations are more complicated to set up as compared to LLCs. Its membership is limited to less than 100 and must be U.S citizens and residents.
  3. An S corporation must have a board of directors and corporate officers.
  4. Business operations are more rigidly structured. They have strict regulations on adopting bylaws, they conduct initial and annual shareholders meetings and maintain company meetings minutes

Limited Liability Company (LLC)

A real estate LLC is a legal entity, separate from the individual investor that has the capability of, owning, purchasing, and managing real estate.

LLCs face substantially fewer regulations regarding their formation. An LLC is allowed to have an unlimited number of members, they can be U.S citizens or non-citizens, residents or non-residents.

Their business operations are also less complicated with minimal requirements.

The general costs of forming an LLC include:

  1. Articles of incorporation fee, which is approximately $100.
  2. Annual reporting fees.
  3. Attorney fees if you have a lawyer draw up the legal documents.
  4. Tax and accounting fees if you use an accounting firm to prepare financials and file taxes.

Resource: How to Get a Loan with LLC

LLC taxation

An LLC is a pass-through tax entity. This means any income earned by the LLC  will pass through the LLC to its members. Therefore the income is not taxed at the corporate level but only at the individual level.

 The procedure of forming an LLC

  1. Choose a name and assign a registered agent.
  2. File the articles of organization of your business stating the LLC structure, members, and managers with their addresses and registered agent information.
  3. Publish the statement of formation.
  4. Create your operating agreement.
  5. Pay the required local fees for operating a business in your country. Most municipalities charge an annual license fee ranging between $50 t0 $250.

To maintain your LLC you must keep refilling your articles of organization each year to avoid penalty or dissolution of your business.

Pros of LLCs

  1. Just like in S corporation, it limits liabilities such as injuries or foreclosure of the real estate to the limited liability company. The owner’s other personal assets are not exposed to risk.
  2. It’s not considered a separate tax entity for income and tax expenses. Under taxation, the LLC passes through all income and expenses to the LLC owner’s tax return. This is much easier than filing corporate tax in addition to individual taxes.
  3. It’s common among real estate developers to subdivide a property. This LLC enables you to distribute part of the entire property without incurring a fully taxable event.
  4. Limited liability companies have fewer legal reporting requirements and easier income distribution processes as compared to S corporations. This makes them more appealing to most real estate developers.

CONS of LLCs

  1. LLC Owners still pay self-employment taxes.
  2. In any event the property had ever been a personal residence, the IRS capital gain experience is forfeited.
  3. They can’t be funded by venture capitalists.

Which is better, an S corporation or a limited liability company (LLC)?

The answer to this question entirely depends on your objective as a real estate investor.

If your goal is to gain rental income from one or two properties and protect your assets, forming an LLC is the best option.

Contrary, if you aim to build, purchase, flip or subdivide multiple properties an S corporation designation will serve you best.

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