Pay my own property management company

11 Replies

Hi, 

I have 17 unit rentals and I have set up a S-corporation acting as property management company. The average property management fee in my area is 10% of the rent collected. How much should I pay to my corporation for the best tax advantage? Is Lower rate better so that corporation doesn't earn much or is higher rate better so that I can deduct more on 1040?

Thanks,

@Sheba Shimoji what you are talking about doing is not allowed by the IRS. The S-Corps income passes through to you and you are solely responsible for the payment of taxes. You can't create an expense by paying your S-Corp which then reduces the amount of personal taxes you pay. Basically its all your money. You cant pay yourself. 

Maybe a better way of saying it is that you cant convert investment/passive income to earned income (management fees). 

@Sheba Shimoji - I am going to disagree with @Rob Beland , BUT, I am going to advise you to seek the advice of your CPA before deciding how/why. Technically, what you are trying to do converts investment income into ordinary income as it passes from your investment company (or you personally) to your business. I personally am not familiar with rules of S-corps, I use LLC's, so I am not in a good position to offer a lot of insight into your question. The resulting conversion of income may actually work AGAINST you, not for you as ordinary income is taxed differently.

I can say that I am a member of multiple LLC's that own real estate. I am also a member of an LLC that is primarily a property management company. My management company charges the holding companies for it's services. The way that we do this is under the advice and supervision of our CPA.

Going back to your original post and question, be careful what you do and how much you charge.  If you can make a reasonable argument that what you are doing is not tax evasion, you will be in a much better position to defend against an audit.  Consult professional advice so that you do this correctly.  First, you don't want to be in a bad spot if ever audited.  Second, you don't want to inadvertently cause yourself to pay more in taxes than what you were originally paying! 

Good luck, happy investing!

@Sheba Shimoji

Disagree with Rob, yes you can do this.  However, if you personally own all the rentals, why would you?  There is essentially no tax advantage to do so.  In fact, you likely pay a bit more in taxes converting passive income (no self employment tax) into earned income.  

This would make sense if you do not own the rentals completely. For instance, if you own 25% of the LLC that holds the rental, and your partners agree to pay you for the management, then I do think you should create a S-corp as a management company, whereby you pay yourself as employee.

This would also make sense that if you want to earn income from managing other people's properties in addition to your own, hence a true property management company.  

**I'm not an accountant**

This could also make sense if one were trying to create self-employed earned income in order to be eligible for a solo 401k. Schedule E income (whether the property is held in one's personal name or in a disregarded entity LLC) does not produce earned income to contribute to a solo account. That's the benefit I see, but check with an accountant!!

@Rob Beland @Adam Johnson @Daniel Chang

Rob is correct here on converting passive income to active income via self-charged management fees. Of course, you can pay your parent S-Corp all day and call it whatever you want, but it doesn't change the economics of the particular transaction.

Generally, you cannot convert passive income/loss into non-passive (ordinary) income/loss. Otherwise, you'd be able to devise tax loopholes to get around the passive activity rules that the IRS worked hard and long at developing :) 

I encourage you to read Hillman vs. Commissioner (Appealed) as it directly relates to this discussion.

Summary of case: Hillman had a parent S-Corp and was charging his subsidiary LLCs a property management fee. Hillman was deducting the management expense from his subsidiary LLCs against the S-Corp active income on his tax returns. IRS issued a notice of deficiency claiming that Hillman could not utilize this method under IRC

Thank you very much everyone for all the great advice.

Honestly, I don't really understand myself why I have S-corp. About a year ago, I was told that I will save tax money through S-corp, and it is good for the asset protection. So I set up an S-corp. All the expenses comes out from the corporation account, but all the rental properties are held under my name, not the corporation. It has been very confusing because my corporation doesn't have a source of income. I deposit my money into a corporation account first to be able to pay the rental expenses. 

A few days ago, I was also told that I need to have a signed contract between myself and my corporation on the property management aspect. That's why I am trying to figure out how much I should pay to my corporation for the property management fee...

My CPA seems inexperienced in real estate field.(I figured out that a few weeks ago when I asked him about 1031ex. He didn't know anything about it...)

Maybe, will it be the best if I close my corporation?

Originally posted by @Sheba Shimoji :

Honestly, I don't really understand myself why I have S-corp. About a year ago, I was told that I will save tax money through S-corp, and it is good for the asset protection. 

My CPA seems inexperienced in real estate field.(I figured out that a few weeks ago when I asked him about 1031ex. He didn't know anything about it...)

Maybe, will it be the best if I close my corporation?

It seems like you are doing a good job with the S-Corp itself (income and expenses flowing through the corp) but I too am confused with your current entity structuring as you describe it. I'd double check with an asset protection attorney experience in real estate law on that issue.

If your CPA doesn't know what a 1031 exchange is, you should drop him/her immediately. It's not that they are necessarily a bad CPA, but real estate investors need specific and tailored advice from a real estate savvy CPA. It's a niche area to be in (from a CPA perspective) on both the market side and the knowledge side. Upon reviewing a new client's tax returns, I can tell pretty quickly if their prior tax advisor had any real estate experience.

Don't close the corp yet. Get connected with an asset protection attorney and a good CPA and see what they have to say.

@Brandon Hall @Sheba Shimoji

Brandon, I defer to your expertise in this matter. However, what I was alluding to is a different scenario. It seems the case you bring up is where the parent S-corp owns through partnerships the subsidiary LLCs. Furthermore, it talked about deducting the management expenses from his LLC against the S-Corp active income. It was vague as to what these management expenses were.

I had assumed that Sheba was talking about where she owned properties in her name or LLCs, and has a separate S-Corp. Hence no parent-subsidiary relationship. Essentially, she would expense a management fee from the LLC and it would be revenue to her S-Corp. The S-Corp would have its own expenses in running a management company (office supplies, software, etc.). While I do not see a benefit in doing this as it would create a greater tax liability, is it your opinion that this cannot be done?

@Daniel Chang great question! Yes you can classify the management fee to the S-Corp as income and you can deduct your necessary business expenses, however the income/loss will still be passive in nature, regardless of how you structure your entities. We look to the economic substance of the transaction, and in the case of rental properties, the income/loss will be passive in nature.

UNLESS: the shareholder of the entity qualifies as a real estate professional for tax purposes. Does that help clear it up?

@Sheba Shimoji - as @Brandon Hall said, it is time to find a new CPA before you go any further.  You are not shopping for best price, you are shopping for best advice.  I spend a lot of money with my CPA and she is worth every penny.  When I have a question, I get a thorough and complete answer, every time, and it is explained in a way that I understand.  I own several businesses, so I have some of my own experience to fall back on BUT when I have a question/problem, it is solved for me.  She has many other clients that have FAR larger real estate portfolios than I do and much larger businesses too.  Her other clients are where I aspire to be and my choice to hire her was because of that.

I would advise you to ask more seasoned investors in your area who they work with.  Interview a few as if they were going to work for you (they will be).  Go with your gut.  I once interviewed an adviser that said something to the effect of "...I've never worked with somebody like you before...", he was not hired.

My CPA quotes us an annual fee for our taxes, general advice, misc. consultations, etc. in advance of the year.  In the event of an unusual or surprise project (such as an IRS audit), that is an additional fee.  But if I call her or email her a question, I don't get a bill for the answer.  I love that.  My previous CPA sent me a bill for every minute on the phone, so I was reluctant to call.  I don't abuse this, but it is nice to simply ask and get an answer.  I have looked at the numbers and I am not really saving any money this way, but I get great service and piece of mind that I can call her at any time and get a thorough answer.

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