What entity should I create?

28 Replies

Hi everyone!

My husband and I are planning on jumping in to the Chicago market and are pursuing fix/flips. We are having trouble deciding which entity(LLC, S-Corp, land trusts, etc.) to create and are looking for advice. Now, we realize that you may/may not be attorneys but maybe if you guys could shed some light on what works for you, that would be fantastic.

Oh, and just to give you some background this will be a first-time flip and we already have an LLC in Georgia for a buy/hold property.

Thanks in advance for any and all advice!

I've read LLCs are not good entities for short-term flips.  I use them with my larger apt bld buy and holds.  They are better set-up for passive income.  From what I understand an S-corp is better for active income.  

The answer may be neither. For what purpose do you want an entity @Sidney S. ?  Asset protection? Anonymity?  Tax advantages?  The only one I see it offering is #2.  I am not a lawyer though.  Cheers!

Your GA LLC will need to be registered in IL to do business in IL. May be cheaper to just start an IL LLC (no duplication of costs). Also, IL allows series LLCs where GA might not - check into that.

Conventional wisdom holds that properties be held in LLCs while income should be processed through an S-Corp.

You'll want to get hold of a tax attorney who understands structuring business entities for purposes of controlling tax liability as well as protecting assets against liability due to lawsuits and other issues. I can refer you, if you need it.

Great question @Sidney S. ! I have been wondering about LLC vs s-corp for flipping houses. For a flip I would be looking for tax advantages/savings. I will start looking into s-corps now.

@Richard McGouirk

@Sidney S. Becuase we have partners we always use LLCs but you must ask the accountant about tax consequences and attorney about asset protection. In Illinois most should tell you an LLC.

@Sidney S. ...I'm in agreement with @Steve Vaughan in regards to the purpose you wish to have the entity. Most use LLC but Land Trust are popular and can help if you don't want to deal with double closings in that you can assign the beneficial interest. As far as I know, LLC and S-corp are similar in taxation but offer the differences in management styles.

It depends on your purpose. Common considerations are asset protection, privacy, taxes, and financing. 

A land trust will not provide asset protection. There are some benefits, mainly privacy of ownership, and those can be read here: 

http://www.idfpr.com/banks/consumer/tips/TRUSTS.ASP

While an LLC and S-Corp do provide limited liability, they're not foolproof. Not all acts will be protected and you must properly maintain the entity and business operations.

The biggest considerations, to me, are financing and taxes. Depending on your options, you may have an easier or harder time securing financing with an entity. 

Tax implications can be the difference between a profitable/losing property. Definitely consult a tax professional. @Steven Hamilton II may have more info.

Finally, Illinois does offer a series LLC which is what I use to hold my long-term rentals.

Originally posted by @Steve Vaughan :

I've read LLCs are not good entities for short-term flips.  I use them with my larger apt bld buy and holds.  They are better set-up for passive income.  From what I understand an S-corp is better for active income.  

The answer may be neither. For what purpose do you want an entity @Sidney Stephens?  Asset protection? Anonymity?  Tax advantages?  The only one I see it offering is #2.  I am not a lawyer though.  Cheers!

 Ok great! Sounds similar to what I've heard. We're looking for tax advantages and asset protection. At this point anonymity isn't of great importance since we're still just starting off.

Originally posted by @David Dachtera :

Your GA LLC will need to be registered in IL to do business in IL. May be cheaper to just start an IL LLC (no duplication of costs). Also, IL allows series LLCs where GA might not - check into that.

Conventional wisdom holds that properties be held in LLCs while income should be processed through an S-Corp.

You'll want to get hold of a tax attorney who understands structuring business entities for purposes of controlling tax liability as well as protecting assets against liability due to lawsuits and other issues. I can refer you, if you need it.

So in essence, create an LLC but run it like an S-corp for tax purposes?

Sure. Please inbox me. 

Originally posted by @Russ Brantley:

Great question @Sidney Stephens! I have been wondering about LLC vs s-corp for flipping houses. For a flip I would be looking for tax advantages/savings. I will start looking into s-corps now.

@Richard McGouirk

I hear you! It would be disappointing to lose out on profits because we failed to opt for the right entity.

Originally posted by @Mark Ainley :

@Sidney StephensBecuase we have partners we always use LLCs but you must ask the accountant about tax consequences and attorney about asset protection. In Illinois most should tell you an LLC.

 Thanks, that makes sense. We still need to locate a CPA in Chicago, since I think that will most likely resolve a few of our questions.

Originally posted by @Jerry Stanford :

@Sidney Stephens...I'm in agreement with @Steve Vaughan in regards to the purpose you wish to have the entity. Most use LLC but Land Trust are popular and can help if you don't want to deal with double closings in that you can assign the beneficial interest. As far as I know, LLC and S-corp are similar in taxation but offer the differences in management styles.

 Thanks for your input! I am not really familiar with land trusts so I will see if they are a good idea for what we're trying to pursue.

Not an attorney but this is my recollection of summary with my attorney.

LLC gives you more flexibility but has to be done by a great attorney. Start with an LLC and make money. When you make enough income, you can file the LLC as a S-corp. The benefits of the S-corp are paying FICA on your "wage that must pass the BS test for the type of job" rather than paying self-employment tax on all of your flip or wholesale income. I am sure there are some investors who are not filing their flip or wholesale income properly and paying self-employment taxes. But you need to make a substantial amount of money to pay yourself a wage. That's why the LLC gives more flexibility.

Anyone chime in if I am missing something in my explanation. 

If you flip or wholesale houses, you don't qualify for a 1031 exchange or capital gains tax. You're what the IRS calls a "dealer". You get taxed as ordinary income unless you use an S-corp or an LLC with the s-corp tax designation. In other words, you cannot roll over your flip profits over to buying rental properties without paying taxes.

Think of flipping like your job. 

Ask your CPA though if you qualify for the "real estate professional" category where you can use depreciation from your rentals to save on taxes.

Flips are taxed as ordinary income regardless of how the property is held. Flips are inventory. You buy inventory, resell it, and owe taxes on the gains. Buy and hold RE is an investment under IRS guidelines. Buy and hold RE is an investment held for gain, has tax advantages such as depreciation, and can be 1031 to defer taxes. Flips cannot. As far as entities, an LLC can elect to be taxed as an S corp if desired. The difference between the LLC and S corp is the structure. As I put in another post, the best protection often is insurance. Talk to your tax guy, an attorney, and insurance agent for guidance.

@Russ Brantley @Sidney S.

For my clients that flip houses, we often try to keep it simple until it's feasible to go the S-Corp route. Start with an LLC and when you expect to earn around $50k net operating income in any given year, that's when you should Be thinking about filing an S election.

That's how you set up S-corps by the way - you either first create an LLC or C-Corp, and then file a form to elect S-Corp status. So you can't go straight to S-Corp if that makes sense.

Hope this helps.

Originally posted by @Brandon Hall :

@Russ Brantley@Sidney S.

For my clients that flip houses, we often try to keep it simple until it's feasible to go the S-Corp route. Start with an LLC and when you expect to earn around $50k net operating income in any given year, that's when you should Be thinking about filing an S election.

That's how you set up S-corps by the way - you either first create an LLC or C-Corp, and then file a form to elect S-Corp status. So you can't go straight to S-Corp if that makes sense.

Hope this helps.

 Thank you for the advice @Brandon Hall. I've heard similar advice from others about waiting until net operating income gets above a certain amount before creating an s-corp. Sounds like a good idea. I don't want to complicate things too much in the beginning. 

What everyone else said, but I do want to add one point that might not have been mentioned.

Depending on how you finance your deal-check with your lender, some lenders might not allow you to close in an LLC.

If you're using your own money or private money this won't be an issue, but just something to consider.

Originally posted by @Ryland Taniguchi :

Not an attorney but this is my recollection of summary with my attorney.

LLC gives you more flexibility but has to be done by a great attorney. Start with an LLC and make money. When you make enough income, you can file the LLC as a S-corp. The benefits of the S-corp are paying FICA on your "wage that must pass the BS test for the type of job" rather than paying self-employment tax on all of your flip or wholesale income. I am sure there are some investors who are not filing their flip or wholesale income properly and paying self-employment taxes. But you need to make a substantial amount of money to pay yourself a wage. That's why the LLC gives more flexibility.

Anyone chime in if I am missing something in my explanation. 

Thanks for the great info! I am looking to start an LLC, how do i go about doing this? Do i hire a Real Estate Attorney or a Tax Attorney?

Call your CPA.  That's what you're paying him for. 

Mine said to use a S-Corp based on the business plan I told him. 

Either way, don't let this be a roadblock.   A lot of people get hung up on stuff like this and just end up wasting time.  Get a deal going and get in touch with the CPA.  You can transfer the property into the company (if you choose one) afterwards.

Originally posted by @Trevon Peracca :
Originally posted by @Ryland Taniguchi:

Not an attorney but this is my recollection of summary with my attorney.

LLC gives you more flexibility but has to be done by a great attorney. Start with an LLC and make money. When you make enough income, you can file the LLC as a S-corp. The benefits of the S-corp are paying FICA on your "wage that must pass the BS test for the type of job" rather than paying self-employment tax on all of your flip or wholesale income. I am sure there are some investors who are not filing their flip or wholesale income properly and paying self-employment taxes. But you need to make a substantial amount of money to pay yourself a wage. That's why the LLC gives more flexibility.

Anyone chime in if I am missing something in my explanation. 

Thanks for the great info! I am looking to start an LLC, how do i go about doing this? Do i hire a Real Estate Attorney or a Tax Attorney?

Most real estate attorneys should be to draft these up. Talk to your CPA as well regarding your specific tax situation. I am assuming that people know that they cannot get legal or tax advise on BP but trying to know what questions to ask their advisory team.

As Steve Vaughn said, it depends on your goals for the entity.  However, be careful because all LLCs are not created equal.  They are a state authorized entity and the protections of asset and anonymity are differed state by state as well as the permissibility of using foreign registered LLCs in a given state.

If you end up holding for purposes of productive use and 1031 exchanges I'm a fan of LLCs because they are disregarded for sole members when the activity flows through to their personal return.  When there are multiple members it is a relatively simple member to dismantle them at the end of a 1031 if the members want to go separate ways.

Originally posted by @Ryland Taniguchi :

Not an attorney but this is my recollection of summary with my attorney.

LLC gives you more flexibility but has to be done by a great attorney. Start with an LLC and make money. When you make enough income, you can file the LLC as a S-corp. The benefits of the S-corp are paying FICA on your "wage that must pass the BS test for the type of job" rather than paying self-employment tax on all of your flip or wholesale income. I am sure there are some investors who are not filing their flip or wholesale income properly and paying self-employment taxes. But you need to make a substantial amount of money to pay yourself a wage. That's why the LLC gives more flexibility.

Anyone chime in if I am missing something in my explanation. 

 I hear you! Thanks for advice. You certainly shed some light on some other questions that were coming to mind.

Originally posted by @John Thedford :

Flips are taxed as ordinary income regardless of how the property is held. Flips are inventory. You buy inventory, resell it, and owe taxes on the gains. Buy and hold RE is an investment under IRS guidelines. Buy and hold RE is an investment held for gain, has tax advantages such as depreciation, and can be 1031 to defer taxes. Flips cannot. As far as entities, an LLC can elect to be taxed as an S corp if desired. The difference between the LLC and S corp is the structure. As I put in another post, the best protection often is insurance. Talk to your tax guy, an attorney, and insurance agent for guidance.

 Wouldn't an S-corp also offer you tax benefits? (following up with a CPA :D)

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