How do I “cash out” my cash flow through an LLC?

[Christine Brown]

Hi all, I'm about to purchase my first STR in Texas through my LLC (and I live in California). How do I "cash out" my cash flow from the property when the time comes, and not lose it all to taxes?

(A quick note - I'm planning on reinvesting most of the profits, but this question is specific to anything I want to keep personally as supplemental income)

[E.J. McCaffrey]

Congratulations on your first short-term rental (STR) investment! Since you're purchasing the property through an LLC and live in California, it's important to understand how to take money out for personal use without triggering unnecessary taxes.

Even though your property is located in Texas, a state with no income tax, your residency in California means you'll owe California state income tax on the rental profits. If your LLC is structured as a pass-through entity, all rental income is reported on your personal tax return, regardless of whether or not you actually withdraw the money. In short, you are taxed on the business's net profit, not on how much cash you transfer to yourself. So when you "cash out" by moving funds from your business bank account to your personal one, you're not creating additional taxes since you've already paid tax on those profits.

There are several strategies you can use to reduce the amount of tax you owe on that income. One of the most powerful is using depreciation, especially if you qualify as materially participating in the STR. Material participation means you are actively involved in the property's operations, and if that's the case, the STR income is considered non-passive. This status allows you to take depreciation deductions, including accelerated depreciation or cost segregation, which can significantly reduce your taxable income. In some cases, these deductions can even offset income from other sources, like W-2 wages.

Another simple way to access business funds without tax consequences is through reimbursements. If you cover rental-related expenses personally, such as furniture, travel, or repair, your LLC can reimburse you. These payments aren't considered income; they're just repayments for out-of-pocket business costs.

You might also benefit from setting up a an LLC taxed as a C Corporation, to act as a management company for your STR. This C-Corp can charge your rental LLC a reasonable management fee for services like reservations, marketing, and maintenance coordination. This shifts income from your personal return (where you may be in a high tax bracket) to the C-Corp, which is taxed at a flat federal rate of 21%. The C-Corp can then pay you a salary or offer you tax-advantaged benefits such as healthcare reimbursements or contributions to a retirement plan.

To take things a step further, you could hold the property in a disregarded LLC and lease it long-term to your C-Corp management company. The C-Corp would then handle the short-term rental operations. This structure allows you to earn passive rental income from the property-holding LLC, taxed at a lower rate, while the active STR income flows through the C-Corp, giving you more flexibility and planning opportunities.

Best of luck!

Note: This information is for educational and informational purposes only and does not constitute legal, tax, financial, or investment advice. No attorney-client, fiduciary, or professional relationship is established through this communication.