This may be a basic quesstion, but I'm in the beginning stages of researching for my first investment property. For liability purposes, all of my properties will be owed by a corporation that I'll be setting up. I assume that to maintain the security vail, the financing must also have the corporation's name on it - not mine. If that's the case, how do the financing institutions determine credit worthiness? Do they use my credit and assign it to the corporation, or does having my name on the loan not affect the separation between my corporation and my personal liabilities?
Just to start off, you can look me up and see my credentials. I represent taxpayers such as yourself before the IRS.
Now, on to the fun.
S-corps
Debt is not considered basis therefore you WILL be subject to tax if you distribute proceeds from a cash out refinance or any proceed beyond your exact cash contribution.
Deemed Sale
Typically for a property that you are planning to hold long term, it is recommend that you hold them personally or in a disregarded entity such as an LLC. In many states it can be considered malpractice to advise holding RE long term in a C or S-corp. This is due to the fact any transfer of the property is considered a "deemed sale". This means if you take it out of the corp to keep personally, The corp pays tax on the "gain" between basis and FMV AND you pay tax on the full FMV as a dividend.
I have an examples I will share here:
The corporation will have to recognize a gain/loss on the property. I found a perfect example to give. Assuming no other income and a 5% state tax rate.
I the property was purchased for 500k 10 years ago, and now there has been 200k of depreciation. Meaning adjusted basis of 300k. At sale/dividend Fair Market Value is $1million. There is recapture of 200k. There is then gain of 500k. This would result in tax of $278,841. Plus 5% to state: 35,000
Corporate tax total: 313,841.
The the shareholder that received the dividend would receive a dividend of $1 million. That they would pay 20% on. That would mean a capital gain tax of 200,000 PLUS state tax of 5% = 50,000.
Personal tax total: 250,000
Total tax on dividend/ distribution = $563,841.
This is why it is considered malpractice in some states to advise holding real estate in a C-corp.
You LOSE the Long Term Capital Gain Rates with a corp.
You will pay tax at the corporate rates:
TAXABLE INCOME: TAX:
Over But not over Tax +% On amount over
$ 0 $ 50,000 $ 0 15% $ 0
50,000 75,000 7,500 25% 50,000
75,000 100,000 13,750 34% 75,000
100,000 335,000 22,250 39% 100,000
335,000 10,000,000 113,900 34% 335,000
10,000,000 15,000,000 3,400,000 35% 10,000,000
15,000,000 18,333,333 5,150,000 38% 15,000,000
18,333,333 ............ ............ 35% 0
Skewed Step up in Basis for Heirs
Now, lets say you keep that Rental property in the corporation forever, Yes you can 1031 into something else; however, your kids will not receive much of a benefit as the deemed sale of ANY transfer will cause taxation. The only way around it is a 1031 exchange. Meaning there won't be personal use of the property. The kids will receive a stepped up basis in the corp stock and yes it could be dissolved, but the transfer still causes a sale meaning corp tax due. The dividend would be a return of capital.
Worst one:
**********************
Personal Holding Company Tax
************************
PHC tax is applied when a corporation is used to hold passive income in an attempt to remove it from an individual's return. This means if the corp has greater than 60% of its income from passive activities than it will be subject to a penalty tax of: 20% in addition to the regular tax rate. Thereby making the base tax rate 35%.
Please ask if you have questions or need clarification.
-Steven
You'll have a very difficult time getting financing on property in the name of an entity unless you can find a commercial lender.
Good luck,
Mike
Thanks, so the standard procedure is to obtain financing in your name, but put the property under the corporation? Not sure how that would work since the lender needs to see the borrower's name on the title. I know most investors use a corporation to protect themselves, for those of you who have done this, how does it all work out?
First I suggest you absolutely not put RE in a C corporation you should be using an LLC with a "S Corp" or "Partnership" unless you really love paying taxes.
Financing in any business entity will mean commercial financing with a personal guarantee, there are very few instances where lenders will finance RE without your personal signature. If you're starting out you may not need a business entity, load up on insurance and manage your property well so that you aren't negligent in the first place.
Do some more reading here on business structures and I'd suggest you speak to an attorney to put your entity together and a tax professional before you do anything. :)
That is not universally true.
A C corporation can retain earnings, a pass through entity cannot.
There are lots of scenarios and situations where the combined tax rate using a C corp is lower than the marginal rate offered by a pass through.
The bottom line is each situation is different and not all problems are nails just because you know how to use a hammer.
A few instances, not lots, like flipping, and they usually won't apply to those starting off or buying to hold long term. And, giving the wrong impression can be very costly to someone, so let's let a tax advisor consult our new folks. I don't give tax advice, except to myself. LOL :)
Wow, just wow. It's a heckuva lot more than a few instances.
The fact is most of those just starting out don't need any kind of entity at all.
The deal I am putting together in WA state will be in a C corp based on the advice of my attorneys and tax professionals.
Why?
There are a number of reasons not the least of which is it can retain earnings at the lower corporate rate, it can have employees and provide significant benefits to those employees and to the corporate officers, it is large enough to warrant the yearly overhead of C corp compliance and I am using private funding through stock warrants.
The list goes on.
A C corp is not just for flipping. I wonder about the advice you received from your tax planner if you honestly believe that and have based that belief on their advice.
Wow, just wow. It's a heckuva lot more than a few instances.
The fact is most of those just starting out don't need any kind of entity at all.
The deal I am putting together in WA state will be in a C corp based on the advice of my attorneys and tax professionals.
Why?
There are a number of reasons not the least of which it can retain earnings at the lower corporate rate, it can have employees and provide significant benefits to those employees, it is large enough to warrant the yearly overhead of C corp compliance and I am using private funding through stock warrants.
The list goes on.
A C corp is not just for flipping. I wonder about the advice you received from your tax planner if you honestly believe that and have based that belief on their advice.
I'm not sure why everyone starting out wants to start putting properties in corp, llc, etc etc. If your worth a few hundred million, then you might need to do that,,if not, get a several million dollar umbrella policy treat people right and keep your properties up to date.
To get maximum cash flow you need to get a 30 year traditional mortgage at around 4 1/2-5% locked in for 30 years, not a commercial loan at 6-7% that the rate is only locked in for a few years.
Your allowed to have 10 mortgages in your personal name, use those first, if your spouse has income and can qualify for mortgages, put 10 in his/her name,,,
There are very few (but I didn't say there weren't any) reason for a person starting out shouldn't be putting properties in their personal name unless they are worth a LOT of money, as long as your dealing in single family.
Take the time your spending looking at different corporate structures and spend it looking for a deal and putting in offers.
andy
My situation is a bit different, I'm a business owner as well in another field - so the time spent protecting my other assets is worth it. I wouldn't go into any other sort of business without forming an LLC or corporation around it, so I'm not treating this endeavor any different. If anything, there's greater risk with real estate than my other businesses. Treating tennants properly is fine, but that one time there's some black ice in the driveway or a passerby trips on a branch that fell from a tree outside, etc. People will sue for anything these days, why not spend the time to protect yourself? That way, when something does happen, you can spend your time moving on in your life rather than filing personal bankruptcy and loosing everything. Of course, that's just my opinion. I was more asking about how the finance companies work it out, rather than whether or not I should be forming an entity.
If you personally guarantee the note, if you manage the property, if you had anything to do with the rehab,,your tied to it even if you hold the property in a corporate structure 10 entities downline from you.
There is NO getting away from personal liability IF you manage the property, are responsible for the property and its upkeep, or your personal name is tied to the note in anyway.
Go talk to a lawyer that you trust, ask them how to keep all liability from your personal name,,they will probable tell you to not invest in real estate, even silent partners can at times be brought into lawsuits.
If you have a $5 Million umbrella policy you shouldn't have a problem unless you leave a leaky gas line unfixed after you were notified and someone is killed,,then bankruptcy is the least of your problems.
If you are going to form the entity then forgo the lure of the lower interest rates and go for a commercial loan. I don't personally know a commercial loan broker in NY, but I will ask around tomorrow and see who I can come up with.
If you do the financing in any other way you will substantially weaken the protections an LLC can provide.
I urge you, even beg you, to seek the counsel of a competent estate and tax planning professional in your area. They can help you with the commercial financing too.
Having said all of that, having an entity structure, even a solid one, does not in any way negate the need for a good personal liability umbrella with an appropriate level of coverage.
Mr. Taylor, were your remarks an attempt to inform me of something? They didn't. Aaron is obviously brand new, and comments made are directed to the OP in that light, I seriously doubt he's got 12 employees and starting off offering a 401K. I doubt too he's going to have any stock offering, I have no idea how you took it there unless you just wanted to make a point us to your situation, good luck on your IO! Don't forget to load up on your key man policy and golden parachute as CEO, lease a new Caddy while you're at it. Maybe a stock split early on. Make sure it's well capitalized or Bain Capital may try to take it over.
His comment was to liability protection much like all of our rather new members and that's where we begin addressing such issues. Small investors can get in a real mess putting properties in a C Corp. We recently had to try to solve such a mess with a new member who had a corp. property held for years, a thread @Steven Hamilton II and I addressed.
Andy, you're absolutely right, most starting off really don't need any business entity. Most should get away from the guru notions of protecting imaginary assets. Insurance and good management are all you really need starting off.
Folks, there were landlords, flippers and RE operators way before LLCs were invented. For most in modern history we only had C and S Corps and it was very common for individuals to hold 10 or 20 or more properties personally. :)
Edited as there was a post while I was typing.
Aaron, we like to get all the info we can initially so advice is appropriate, now, I agree with Duncan, get competent advice, not off the internet. A well managed LLC may do all you need and your corporation could also be a member of the LLC, but it sounds like you want them separate. Slip and falls are best taken care of with insurance as well as other RE liabilities. Speak to your attorney as you can have "back door" issues since your stock is an asset you own and so will your interests in any other entity. Risks should really be assessed and managed rather than jumping off the deep end. Good luck. :)
Not really, there is no point. You obviously know everything about how an LLC or S-corp is the solution for every need, right? A C corp is only appropriate for flipping, right? And since he is not flipping, well, let's just pound that nail home with our shinny pass-through hammer.
From what he has described here, I'd be very surprised if a competent tax planner or attorney would recommend an LLC as the only thing he needs to add to his overall strategy if he really needs the protection he thinks he needs.
Bill, I think you need a new hammer. Some of those things you were pounding on weren't nails.
:rolleyes:
So far, you're not posing any valid or specific reasonable objection to what I mentioned, just poking saying or trying to say I'm not correct or it's a bad idea, so explain.
I'm tossing out my opinions and not giving Aaron advice to do this or that, I don't have enough details to even consider that and neither do you. :)
Thanks guys, I appreciate all of the different view points! Didn't mean to start a war, although it's all good info from both sides of the fence. I'll be consulting an attorney for sure just to weigh my options and figure out exactly what path I need to take, clearly it depends on the individual situation.
Just to start off, you can look me up and see my credentials. I represent taxpayers such as yourself before the IRS.
Now, on to the fun.
S-corps
Debt is not considered basis therefore you WILL be subject to tax if you distribute proceeds from a cash out refinance or any proceed beyond your exact cash contribution.
Deemed Sale
Typically for a property that you are planning to hold long term, it is recommend that you hold them personally or in a disregarded entity such as an LLC. In many states it can be considered malpractice to advise holding RE long term in a C or S-corp. This is due to the fact any transfer of the property is considered a "deemed sale". This means if you take it out of the corp to keep personally, The corp pays tax on the "gain" between basis and FMV AND you pay tax on the full FMV as a dividend.
I have an examples I will share here:
The corporation will have to recognize a gain/loss on the property. I found a perfect example to give. Assuming no other income and a 5% state tax rate.
I the property was purchased for 500k 10 years ago, and now there has been 200k of depreciation. Meaning adjusted basis of 300k. At sale/dividend Fair Market Value is $1million. There is recapture of 200k. There is then gain of 500k. This would result in tax of $278,841. Plus 5% to state: 35,000
Corporate tax total: 313,841.
The the shareholder that received the dividend would receive a dividend of $1 million. That they would pay 20% on. That would mean a capital gain tax of 200,000 PLUS state tax of 5% = 50,000.
Personal tax total: 250,000
Total tax on dividend/ distribution = $563,841.
This is why it is considered malpractice in some states to advise holding real estate in a C-corp.
You LOSE the Long Term Capital Gain Rates with a corp.
You will pay tax at the corporate rates:
TAXABLE INCOME: TAX:
Over But not over Tax +% On amount over
$ 0 $ 50,000 $ 0 15% $ 0
50,000 75,000 7,500 25% 50,000
75,000 100,000 13,750 34% 75,000
100,000 335,000 22,250 39% 100,000
335,000 10,000,000 113,900 34% 335,000
10,000,000 15,000,000 3,400,000 35% 10,000,000
15,000,000 18,333,333 5,150,000 38% 15,000,000
18,333,333 ............ ............ 35% 0
Skewed Step up in Basis for Heirs
Now, lets say you keep that Rental property in the corporation forever, Yes you can 1031 into something else; however, your kids will not receive much of a benefit as the deemed sale of ANY transfer will cause taxation. The only way around it is a 1031 exchange. Meaning there won't be personal use of the property. The kids will receive a stepped up basis in the corp stock and yes it could be dissolved, but the transfer still causes a sale meaning corp tax due. The dividend would be a return of capital.
Worst one:
**********************
Personal Holding Company Tax
************************
PHC tax is applied when a corporation is used to hold passive income in an attempt to remove it from an individual's return. This means if the corp has greater than 60% of its income from passive activities than it will be subject to a penalty tax of: 20% in addition to the regular tax rate. Thereby making the base tax rate 35%.
Please ask if you have questions or need clarification.
-Steven
Wow, just wow. It's a heckuva lot more than a few instances.
The fact is most of those just starting out don't need any kind of entity at all.
The deal I am putting together in WA state will be in a C corp based on the advice of my attorneys and tax professionals.
Why?
There are a number of reasons not the least of which is it can retain earnings at the lower corporate rate, it can have employees and provide significant benefits to those employees and to the corporate officers, it is large enough to warrant the yearly overhead of C corp compliance and I am using private funding through stock warrants.
The list goes on.
A C corp is not just for flipping. I wonder about the advice you received from your tax planner if you honestly believe that and have based that belief on their advice.
As I said, a few instances and you're might be one, but not for a small investor.
Thanks Steven for laying it out!
I'd rather not have the tax liability at all from a C Corp, the only thing would be a flip or properties held short term as I really wouldn't want the recapture issues outlined by Steven.
Well, I have "had" a couple C Corps, but under Section 401C3, so I (we)didn't have these issues, a tad more creative working with other taxable entities. If you want to do larger deal, check out Section 42 of the Code with a 401C3. :)
Your deemed sale example assumes the property is taken from the corporation and converted to personal use by the taxpayer. From the start of the thread I don't think anyone thought or thinks it is a good idea to put a personal residence in a corporation.
My problem with @Bill Gulley's example is the broad stroke of C corps being a bad idea for holding income producing property you never intend to convert to personal use.
So, we are talking apples and oranges here.
The net-net is no one in their right mind with competent advice from a tax professional would put a personal residence in a corporation.
Also, no one in their right mind with competent advice from a tax professional would ignore the advantages of using a C corporation when the situation warrants its use for holding income producing property short or long term.
Just wanted to make sure no one reads this thread and thinks I am advocating holding a personal residence in a corporation, that was never the case.
Now, I have a plane to catch since I was released by my surgeon this morning.
Happy New Year to everyone! If anyone is in the Seattle area, I will be at IGC in Kenmore, WA on NYE, I'd love to meet some of you in person and am looking to try out my new knees on the links soon!
Duncan, yes, but it's on any transfer unless you use a 1031, refinancing and passing funds through for other projects can be an issue. The subject here is small investors, those few instances I mentioned would be for investors that would not be dealing outside that entity, not need funds for outside needs, would hold long term, would pay the higher tax rates for the benefits, but small investors usually require more flexibility.
For those under $10M, I'd suggest a family trust or LLC as both can work into an estate plan. Even better when you incorporate your trust with the LLC and have provisions for the renewal of the LLC, but take care that renewal is an option, not a requirement.
To set out and state that C Corps are a good way to go just isn't good advice, but is for larger and a few investors. If I had the lease on the Empire State building I might use a C Corp, but not for 25 houses which is more than most hold here on BP. Just being realistic on this site.
Surgeon doesn't sound good to me, get well! :)
Your deemed sale example assumes the property is taken from the corporation and converted to personal use by the taxpayer. From the start of the thread I don't think anyone thought or thinks it is a good idea to put a personal residence in a corporation.
My problem with @Bill Gulley's example is the broad stroke of C corps being a bad idea for holding income producing property you never intend to convert to personal use.
So, we are talking apples and oranges here.
The net-net is no one in their right mind with competent advice from a tax professional would put a personal residence in a corporation.
Also, no one in their right mind with competent advice from a tax professional would ignore the advantages of using a C corporation when the situation warrants its use for holding income producing property short or long term.
Just wanted to make sure no one reads this thread and thinks I am advocating holding a personal residence in a corporation, that was never the case.
Now, I have a plane to catch since I was released by my surgeon this morning.
Happy New Year to everyone! If anyone is in the Seattle area, I will be at IGC in Kenmore, WA on NYE, I'd love to meet some of you in person and am looking to try out my new knees on the links soon!
Duncan,
No one was talking abut or said principal residence. There are numerous reasons to transfer a property such as contribution to a partnership or business, change in use, etc.
That could be as simple as a rental or business property that they only want to sell the business but not the building. Often this is the case. A company wants the business but not the building.
Even if it is sold it is a deemed sale and NO capital gains tax. I gave many scenarios. It could have been transferred to a C-corp by mistake. It is not for long term holding. In some places it can be construed malpractice to advise holding real estate in a C-corp.
"Also, no one in their right mind with competent advice from a tax professional would ignore the advantages of using a C corporation when the situation warrants its use for holding income producing property short or long term."
Could you clarify that as you had conflicting statements.
Let's cut him some slack, just out of surgery I think he's on pain meds. A C Corp fits with his needs in setting up the sale of stock to probably qualified investors, which he'd like everyone to know about, but doesn't get it that new RE investors don't go there.
I also wouldn't doubt his attorney and CPA is ripping him off in setting this up since they see $$$$$$ in the deal as they are most likely going to be involved for the long run as you can do much the same thing with a couple other entities, but whatever. :)
For those under $10M, I'd suggest a family trust or LLC as both can work into an estate plan. Even better when you incorporate your trust with the LLC and have provisions for the renewal of the LLC, but take care that renewal is an option, not a requirement.
To set out and state that C Corps are a good way to go just isn't good advice, but is for larger and a few investors. If I had the lease on the Empire State building I might use a C Corp, but not for 25 houses which is more than most hold here on BP. Just being realistic on this site.
Surgeon doesn't sound good to me, get well! :)
Funny thing about your Empire State comment. I would use an LLC these days and keep it disregarded. Now the management company for it would probably be a corp of some type.
I also wouldn't doubt his attorney and CPA is ripping him off in setting this up since they see $$$ in the deal as they are most likely going to be involved for the long run as you can do much the same thing with a couple other entities, but whatever. :)
No pain meds, the knee replacement surgery was a couple of months ago.
Now, you know, it is entirely possible my tax attorney is ripping me off. After all, I've only known him for over 40 yrs starting back in high school. But, it is also possible he knows a wee bit more about the proper use of an entity structure than a real estate agent who has self filed his LLCs and a tax preparer trained by H&R Block.
Nah, the more I think about it, yeah, you're probably right, I'm the one getting ripped off. :rolleyes: