S-Corp and LLC? Tax Attorneys in Austin, TX area

10 Replies

Hello All!

I was recently advised that the best way to setup a new investor business is create two separate companies. Both a S-Corp and LLC. I was advised that an LLC should ONLY hold property (up to $1M) while the S-corp will pay employees, business expenses, receive rent etc. Benefits from having both is that you can not be double taxed on money with a S-Corp. In addition, when a property is passed from you, to S-Corp to LLC, there is no paper trail associating you with any homes if, for any reason, the LLC is sued, it can not be traced back to you personally.

Can anyone shed some light on why (or why not) you would want to create both a S-Corp and a LLC? In addition, can anyone recommend a good Tax Attorney for advice on this topic in the Austin area for further information?

Appreciate your help in advance.

Thank you!

Stephanie

Hey Stephanie!

There is a lot that may not be expressed quite right, I think (sorry).  Correct me if I'm wrong.

Let's start with nomenclature. Entities are creatures of state law. GPs, LPs, corporations, LLCs, and Series LLC are the biggies. (fun fact: a trust is not an entity) S-corp and C-corp are tax structures under federal tax laws. For instance, an LLC can be treated as an S-corp or C-corp or disregarded (for tax purposes). If any member of an LLC is another company or corporation (there's a difference), then S-corp is not an option.

Now, allow me to reframe your position and tell me if this is correct: one entity to hold property and another entity to run business operations.

If that sounds like what you were thinking, that is a common strategy.  You separate the holding company for a number of reasons: rental income is taxed at a some of the lowest rates, and the risk of loss is different in character than that of running operations, its tax filing looks different (as a business) than a business that runs operations (deducting capital improvements, etc.), among others.  The holding company pays the business operations company to manage the properties. 

The "ops" company provides services, has employees, and character of risk of loss is different than the holding company.  From a tax POV, it deducts costs of labor from gross receipts.

You mentionted that you should cap the value of the property in the holding company at $1M.  That is a personal choice based on your appetite for risk.  For a large asset, that might not even be possible.  

Your first line of defense against loss is going to be insurance on the property, then an umbrella or excess-lines policy on the company.  The policies are there to satisfy claims against the company and preserves the assets.  Your second line of defense will be maintaining the corporate/company formalities.  

After that is when segregating assets among entities becomes important.  Only the assets within each entity are typically available for satisfying claims against it.  Look at is probability of sustaining a loss that exceeds the levels of coverage.  

Also consider the frequency and amount of loss.  In normal words: are you looking at a lot of $10K losses from minor claims or one loss worth $50M?  That will depend on the types of property you have, business operations, and who is likely to make a claim.  Luxery rentals in exclusive resort areas, where short-term renters typically drive up in a Lamborghini and wearing enough diamonds to blind a person v. 3/2/2 brick on slab in a subdivision rented to a blue-collar Joe.  Those are very different risk profiles.  

Keeping the property maintained will reduce risk of loss from a claim.  If the property is fixed up, then there is less chance of someone tripping over a broken sidewalk, electrocuting themselves on out-of-date wiring, or water heater exploding because of corrosion.

Just a few thoughts.

Honestly, I am having hard time with the fact that someone would recommend this setup for a new investor. You need to be concerned with getting your first deal done, and doing a deal that cash flows. You need to be concerned with learning the ropes. You do not need all this added complexity. Paying a qualified attorney to get this setup properly would likely wipe out all of your profit from your first rental. That just doesn't make any sense. An umbrella policy from a reputable insurance company, in the amount that makes sense for you, will give you the legal protection you need to get started, for a fraction of the cost. Once you get a few properties under your belt, it may make sense to revisit this. That's my $.02.

Also, to address your actual question, I have 23 units, and I have 0 employees. I have partners, I have property management, I use contractors - no need for employees. I have no need for an S Corp. That may change some day, but it doesn't make sense for me to hire an employee at this scale. That said, I do have multiple LLCs that are taxed as partnerships (not S Corp). That made sense for me once I started working with partners.

@Kris Wong Do you create your LLC after closing your first deal? I was on the same boat like Stephanie and at first I was all worried about setting up the legal entity first before getting the deal just because I don't want to deal with paper trail at the end. Then I feel like I should just get my foot in the door and actually get my first deal in place. That is just conflicting for us newbie.

@Mora Clark no I id not. I had done several deals before I created an LLC. I did not create an LLC until I had split ownership in a property. Also, what everyone needs to keep in mind, if you want the best rates when financing your deal, you will need to get a conforming note from a conventional lender (talking residential property). You cannot take title in an LLC at the closing table. There are lenders that will allow you to do this, but you will pay a higher interest rate for that privilege. You can transfer title to an LLC, via warranty deed, after closing. The note will still be in your personal name. This technically violates the due on sales clause, but I have not heard of any lender calling the mortgage due as a result.

@Kris Wong that's very interesting! I always think that is better to have an LLC for tax benefit as well as to protect your personal assets. Never thought of the loan part. Thanks for sharing! :) lots to learn here

Generally speaking, an LLC does not give you tax benefit in the case of holding rental property. The IRS does not require a legal entity in order to qualify for having business income and expenses. Also, an umbrella policy can protect your personal assets.

Thanks to all who commented! It's all super helpful in my next steps to becoming a real estate investor. 

@Jerel Ehlert - do you know of any tax attorneys here in the Austin area?

@Kris Wong - do you possibly have any time to meet up? I'd love to pick your brain :) 

@Stephanie Banno , yeah, me. :)

Kris is right in that you don't need this setup to start.  You can buy in your name, then deed it into the entity later (and this is how you get the financing in your name).  You split it up like this to keep the character of income and type of risk together.  Rental income is taxed differently than flip or wholesale income.  Tenants pose a different type of risk than running rehab crews.