C-Corp or S-Corp

27 Replies

My husband and I set up our business as a C-Corp, in order to take advantage of the tax benefits/write offs as well as the asset protection that the C-Corp allows for. However, the first year I went to have the business taxes done, the tax preparer asked why we were not filing as an S-Corp. According to him, a C-Corp can elect to be designated as an S-Corp for tax purposes, but it depends on the type of business that the corporation engages in. I was told by another in the real estate business, that real estate is NOT one of those that can change over to an S-Corp. Does anyone have any insight into the allowability of us changing to an S-Corp with the IRS, and what that would mean for the tax write offs and asset protection?

I cannot remember why, but I was told by two CPAs never to hold my rental properties in a C corp. I was told to either have the entity taxed as an S corp, partnership or disregarded entity. Only an LLC can be taxed as everything. A corporation can only be taxed as a C or an S. Maybe someone else can say if they were told the same thing.

I'm pretty sure there are time restrictions on when you can take the S election.

http://www.irs.gov/pub/irs-pdf/i2553.pdf

The reason you don't want to have a C Corp is because it gets taxed twice. The corporation pays taxes on its income and then you pay taxes (capital gains or ordinary) on the distributions you receive from the C Corp. With an S Corp the taxes that the corporation would pay go straight to your personal return, so you are only taxed once. From a liability stand point, I don't think it's worth it because a good insurance policy is the best hedge against risk.

Originally posted by Christa LaFlam:
My husband and I set up our business as a C-Corp, in order to take advantage of the tax benefits/write offs as well as the asset protection that the C-Corp allows for. However, the first year I went to have the business taxes done, the tax preparer asked why we were not filing as an S-Corp. According to him, a C-Corp can elect to be designated as an S-Corp for tax purposes, but it depends on the type of business that the corporation engages in. I was told by another in the real estate business, that real estate is NOT one of those that can change over to an S-Corp. Does anyone have any insight into the allowability of us changing to an S-Corp with the IRS, and what that would mean for the tax write offs and asset protection?

IMO, holding real estate in a corporation (either C or S) is a TERRIBLE idea. (They do work well for a real estate brokerage or property management company though.) The individual who told you that a "real estate business" cannot "change over to an S-Corp" is misinformed.

First, let me say that you are not changing to an S-Corp. A corporation is a corporation is a corporation. The designation of C- or S-Corp is merely a tax election. Electing S-Corp status would have no effect on the asset protection provided by the corporate entity. The tax write-offs, if any, would flow from the corporation to your personal return via a Schedule K-1 and be reported on Schedule E.

Kyle,

For tax purposes and LLC does not exist. You simply have your choice of how you would like to be taxed.

@Christa LaFlam ,

First, you don't need just a tax professional. You need a consistent advisor. Who will know your situation inside and out and can assess it regularly.

Second, @Bill Walston is correct in what he said. I have MANY clients who operate both types of businesses. Most broker's operate as an S-corp; however, an individual agent cannot elect S-corp status. That may be where you heard that rumor. (I would rather not get into explaining that right now) back on to the topic: Corporations are not ideal for holding real estate. Unless you elect S status and leave it that way from the beginning and even then It is more complicated than the situation needs to be.

Third,

Depending upon the cost either go with 1. a single member LLC or 2. keep it in your name. Either way you need a solid insurance policy in place.

-Steven C. Hamilton II

I am an Accountant, but not a tax accountant. With that warning --Generally you want to avoid a C-Corp to "hold" capital assets. I don't generally like to give rules of thumb because the structure should fit how you operate your business and reflect some of the stuff that you have going on in your personal tax return.

With that said, consider this... When you leverage (use debt on) a rental you likely reduce your income on the property. One benefit of real estate is that you might make a few thousand in cash flow, but that is substantially sheltered by the depreciation deduction on your property. So you don't generate much taxable income (generally you will have very little taxable to start unless you have little debt). Often you have other business expense that reduce your income below zero (a common thing in real estate). Now the kicker... If you use an S-Corp, or LP or another "flow-through" legal entity this loss actually flows through to your personal return, reducing your taxes. In an C-Corp your tax loss creates an NOL (Net operating loss) and merely roll forward each year until you have taxable income to offset it in future years. Clearly, you would rather reduce your current personal taxes due rather than reduce your future corporate tax liability from future earnings (if your C-Corp ever generates a taxable profit (which sometimes never happens). There are a few other reasons that I can think of, but generally this is one that people consider. One item to consider is how a C-Corp gets taxed when an asset is sold... Talk to your CPA.

Great subject! Thank you to the original poster who started this thread. I've been researching this topic trying to make the best decision for my business. Currently I have an LLC but I'm considering setting up a real estate brokerage. If I do that I'll more than likely open the brokerage as a C corp and keep the assets in the LLC.

The only other benefit that I've seen to having a C, is the ability to bring in investors. It's something that mid to long term I'd like to be able to do.

@Paul Sedillo ,

In operating your brokerage don't forget to pay yourself a salary.

You do have the option to operate as an S-corp in the beginning and later convert to a C-corp. Paying yourself a salary can be quite important as to avoid the quick increases in tax rate. Keep in touch with your accountant to be sure that you are not keeping too much income in the business. Because after 50k the tax rate increases quite quickly.

-Steven

C corp is very picky on how you can use funds.

All original incorporations are C's, you then file the extra paperwork to become an S.

Just basic info I remember from my accountant.

I think there are advantages to having a CPA that owns some properties on the side as well. Hard to find for sure, but those CPA's see the whole picture.

Whew, there is a lot to chew on here. Let's start by identifying two types of income, passive or unearned and ordinary (think earned income). You will want to establish two different entities for each type of income.

First, let's start with passive income. This is the wonderful income we seek as long term real estate investors. Rental income is passive, therefore there is no Self Employment Tax (SET) paid on it. The very BEST entity for holding these properties is the LLC. The LLC is a disregarded entity as far as the IRS is concerned so they treat it as a sole proprietorship or as a partnership unless the owner's elect to have it taxed as an S-corp. Since this LLC is used ONLY for passive income, it will NEVER be converted to an S-Corp. The income passes through the LLC directly to the partners (you and your husband), and you pay the income tax, but do not pay self employment tax.

Next, let's look at ordinary (earned) income. This can come from lending money, flipping houses, management fees, baby sitting, selling Mary Kay, or any activity that produces wages, tips, commissions, or fees. This entity should be set up separately from your passive LLC so that the two types of income are never commingled.

The LLC offers NO tax advantages for deferring or reducing SET on earned income. As a married couple, there is a great accounting maneuver that accomplishes the same effect as an S-corp up to about $60,000 of ordinary income. (This description of this procedure is too long for this post, but I will address it in the future.) After $60,000 or so, you can file to have your LLC to be taxed as an S-Corp, at which time you get all the advantages of that tax status.

Without going into the detail of this, an LLC is easier to maintain than a corporation AND if offers some protections that a corporation doesn't. Again, watch for future posts.

So if all your husband and your are going to do is own rental property, you simply need LLCs for that purpose. If you're going to have other income, then you should establish an LLC specifically for ordinary income that can be converted to S-Corp status when appropriate.

Good luck!

Originally posted by @Mike McDermott :

...

...there is a great accounting maneuver that accomplishes the same effect as an S-corp up to about $60,000 of ordinary income. (This description of this procedure is too long for this post, but I will address it in the future.)

[and]

Without going into the detail of this, an LLC is easier to maintain than a corporation AND if offers some protections that a corporation doesn't. Again, watch for future posts.

Mike, good info. Did you ever post any more posts regarding the spousal $60k threshold or converting LLC to S-corp treatment and why?

I'm specifically interested in knowing the recommended business entity for a single-member organization strictly for flipping houses. Federal tax rate would be 33% (MFJ) before adding flip income. 

The business plan calls for building up enough income over two years to afford the down payment for a decent-sized multifamily. So, a related question becomes: can single-member LLC#1 (or S-corp) transfer money to single-member LLC#2 tax-free to allow LLC#2 to use the LLC#1 profits from the flips for the down payment on a multifam buy-an-hold?

I know this is a relatively complex set of facts, but I would imagine it's common for folks to flip properties to be able to later acquire buy-and-holds. 

Since this thread has been revived I would also like to add that a friend of mine (who is an adviser) told me that C-Corporations that file as S-Corporations cannot have more than 25% of their income coming from passive sources. 

If you do, the IRS will just disregard the S status and the entity will be taxed as a C corp anyway.

He almost always advises using LLCs unless you are seeking a large number of investors.  

I am trying to get a conventional loan. My rentals are in an LLC that flow through your personal on your tax returns. Now I am being told my DTI is too high since I have all the debt from my rentals. If I had a C corp, this would not hit my personal return. Has anyone else had this problem?

@Raj Tirur , is the debt listed in your personal name or in the name of the LLC? If the debt is in the name of your LLC it should NOT affect your DTI regardless of the tax election of the entity. What most likely is the case, based on the information you shared, is that the debt is in your name even though your LLC holds the properties. If that's the case the debt will affect your DTI. The debt should be offset to some degree by the rental income generated by the rental properties.

I personally feel that a LLC is the way to go. Depending on your circumstances, it may be cheaper to close out your C Corp and start a LLC from scratch. See link below.

http://jostockandjostock.com/legal-blog/tax-implications-of-converting-from-a-c-corporation-to-an-s-corporation/

Great information, I think doing your homework locally and finding that CPA with personal experience when you are ready is the best option. A good CPA understands the advantages of REI and is engaged personally. Until then, protect yourself with insurance.

Hate to bring this post back up but it gave alot of good info. I have a few myself. For tax purposes what's the best route to take. I make around 90k-120k/yr. The only thing I usually write off is my property taxes. And in usually on the cusp line of paying back uncle sam. Which llc would be best for me? S corp or single owner llc. I'm aware of the pass through entity. Trying to chose the best route.

Hey @Adam Carrillo ,

It's a popular topic that resurfaces quite often. Check out this article, as it explains some of the differences between the filing statuses of the entities. It really comes down to what you are trying to accomplish and what your entity (entities) look like. As to your question about taxes, this article may be more useful for you.

I honestly recommend when it comes to finding the "ideal" structure you will want to sit down with a great CPA and just have them map out the different costs and benefits of the structures. Especially finding a CPA with real estate investing experience can make a night and day difference in the advice you get!

@Adam Carrillo , what business are you in?  Is the 90K-120K earned income?  Rental income?  Just what is it that you do?  Entity selection is based, in part, on the type of income generated and the type of business that you own.

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