Choosing between an LLC or S corp for rental property can be difficult. Generally, an LLC is typically better for rental properties than an S corp.3 min read
Updated June 26, 2020:
Choosing between an LLC or S corp for rental property can be difficult. Generally, an LLC is typically better for rental properties than an S corp. However, both offer:
- Liability protection for the owners.
- The chance to avoid double taxation by being taxed as a partnership.
- The ability to easily add new partners.
Understanding S Corps
An S corp is just a standard corporation or other legal entity that has a special tax classification. When forming your corporation, you can choose it to be taxed as either as S corp or a C corp depending on state law.
While this tax classification provides benefits to individual taxpayers on their pass-through income, an S corp is still subjected to the same tax rules as a C corp when property is involved. This particularly applies if a company is trying to transfer ownership of a property.
Transferring Property
In both an LLC and an S corp, taxes for transferring property start out in a similar way. For example, if you own a property that has not depreciated, but you want to transfer it to another entity for liability reasons, the process would be the same in both an S corp or LLC. When you transfer the property and the other entity owns it, you won't have to pay taxes between the fair market value and the basis.
If your property has a mortgage and you transferred it to an LLC, the sections 722, 731, and 752 of the Internal Revenue Code say you should not have to face any tax consequences. If your LLC is the one receiving the property, you'd hold the title, so you wouldn't have any gain on the transfer.
However, if you transferred the property to an S corporation, you might have to pay corporate taxes as noted in Internal Revenue Code Section 357(c). If you're using the S corp to transfer the property back to yourself, you'll see additional tax consequences.
Overall, if you ever want to transfer the property into your personal name or the name of a family member, it's best to prevent the property from ever being owned by the S corp in the first place. This method is only best if you want to sell the property to a third party.
LLC and S Corps in Property Rentals
If you're taking out a loan in your name to pay for a property rental, transferring the property title to an LLC offers you some liability protection. However, the lender could ignore the transfer if they choose.
To know whether an LLC or S corporation is better for your property rentals, the best idea is to talk directly with your lender. They might have special requirements depending on the type of entity, such as a requirement for a personal guarantee for each member. If you add new members after acquiring the property, then you could have a problem when it comes time to sell the property.
If this sounds confusing, the best course might be to use an LLC to hold your real estate properties and an S corporation to manage the business side of things. This shouldn't be too hard, as there aren't many differences in operating an LLC or an S corp besides filing and taxes. Keep in mind that S corp shareholders do actively participate in the business, so they won't be able to offset their S corporation income with potential rental property losses.
One thing you should not do is elect for the S corp designation on your LLC if it owns a property. This is because rental property is passive income for everyone who is not a real estate professional, meaning it won't be subjected to self-employment tax. If your rental is an S corp, you'll need to have payroll, meaning you'll pay Medicare and Social Security taxes.
If you need help with an LLC or S Corp for rental property, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.
FAQs
If you just want to have some rental income from a property or two and protect your assets, you might be better off forming an LLC. However, if your goals involve purchasing, building, flipping, or sub-dividing multiple properties, an S-Corp designation would probably suit you better.
What type of business is best for rental properties? ›
Generally, an LLC is typically better for rental properties than an S corp. However, both offer: Liability protection for the owners. The chance to avoid double taxation by being taxed as a partnership.
Is an LLC or S corp better for tax purposes? ›
LLC owners must pay self-employment taxes for all income. S corp owners may pay less on this tax, provided they pay themselves a “reasonable salary.” LLCs can have unlimited members, while S corps are limited to 100 shareholders.
How does S corp report rental income? ›
Partnerships and S corporations use Form 8825 to report income and deductible expenses from rental real estate activities, including net income (loss) from rental real estate activities that flow through from partnerships, estates, or trusts.
At what point should I switch from LLC to S corp? ›
In general, you'll want to consider converting from an LLC, partnership or sole proprietorship to an S-corp when your profits are greater than the amount that you'd reasonably expect to pay in owner salaries.
Why would anyone choose LLC over S corp? ›
Another advantage of the LLC is that there is greater flexibility in splitting up financial interests. Owners of LLCs can allocate profits and losses disproportionately among owners; an S corporation's profits and losses must be allocated strictly based upon ownership percentage.
What type of rental properties make the most money? ›
What Is the Most Profitable Type of Income Property? Normally, properties in which a large number of tenants can reside will offer the most profit potential. Such properties include apartment buildings or complexes and office buildings.
How much profit should you make on a rental property? ›
Once you've taken all of these factors into account, you can calculate your potential profit. The amount will depend on your specific situation, but a good rule of thumb is to aim for at least 10% profit after all expenses and taxes.
What is the benefit of an S Corp for real estate? ›
Better Benefits
An S-Corp for a real estate agents gives more retirement planning options, such as access to a solo 401(k) plan. You can contribute more annually to a 401(k) than a traditional or Roth IRA, up to $20,500. You also get to contribute a match from the business profits.
What is a disadvantage of an S corporation? ›
Because of the one-class-of-stock restriction, an S corporation cannot allocate losses or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike partnerships or LLCs taxed as partnerships where the allocation can be set in the partnership agreement or operating agreement.
Who pays more taxes, an LLC or S Corp? Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.
Can a single member LLC own an S Corp? ›
However, some LLCs are “single-member” owned for tax advantages. These LLCs are considered disregarded entities by the IRS and are allowed to own a stake in an S Corporation.
What is the self rental rule for S Corp? ›
The self-rental rule in IRC Section 469 applies when you rent property to a business in which you or your spouse materially participates. Under the rule, any rental losses are still considered passive, but the rental income is deemed nonpassive.
Can S Corp pay owner rent? ›
Business owners may qualify to claim the home office deduction if they have their own business and use a portion of their home as their principle place of business. The S corporation can pay you rent for the home office.
What is the passive income rule for S Corp? ›
An S corporation with accumulated earnings and profits that also has passive investment income totaling more than 25 percent of gross receipts is subject to an income tax computed by multiplying excess net passive income by the highest corporate income tax rate ( Code Sec.
What is the benefit of an S corp for real estate? ›
Better Benefits
An S-Corp for a real estate agents gives more retirement planning options, such as access to a solo 401(k) plan. You can contribute more annually to a 401(k) than a traditional or Roth IRA, up to $20,500. You also get to contribute a match from the business profits.
What are the cons of owning property in LLC? ›
Three advantages to using an LLC for rental property are pass-through of income and losses, protecting personal assets, and creating a flexible ownership structure. Drawbacks to using an LLC include possible self-employment tax, difficulty of financing, and annual fees.
What is the best type of company for real estate investment? ›
LLC. A limited liability company (LLC) is a common entity choice for real estate investors and offers many advantages. Choosing this structure for your real estate investment business allows you to limit your personal liability in the business to the money you contribute and the debts you co-sign for.
What is the best business structure for real estate agency? ›
Every business structure has advantages and disadvantages; however, for most real estate agents and brokers, using an S corporation or LLC is the best option.
