S Corp Instead of LLC for Rentals?

Question

I searched for detailed information regarding this before posting, but was hoping for some more distinct answers.

I have 8 units right now in Kansas under one LLC and have a W-2 job. I also have several friends (some with around 15-20 and some with over 50 units) and the LLC seems to be the entity most have chosen after researching and getting legal advice. I do however know one person who chose an S Corp and she has probably 30-ish units. Many of these friends I know have similar situations, some though are completely self-employed with passive income and some have W-2 jobs as well. I don't see a rhyme or reason as to why someone with the same situation would go for an S Corp over an LLC or vice versa. All of these people are in Kansas.

One of my co-workers decided this month to buy a new residence and keep his old one as a rental. This would be his first rental property but he'd like more in the future. He spoke with his accountant and they suggested setting up an S Corp instead of an LLC, because there are some "long-term benefits" supposedly. They also told him passive income like rentals are better in an S Corp because you can carry over more business loss to your personal tax side to offset personal income. I haven't found anything to support this.

Could anyone provide some clarity as to why some CPA's and Attorneys say do LLC, and some S Corp?

Linda Weygant · Answer

In general, holding property in an S-Corp is a pretty bad idea.

1. If more than 20% of the revenues in the S-Corp come from a passive activity (which rental income falls under), the IRS can choose to negate your S-election and convert you to a C-Corp. You are then subject to all the double taxation issues that involves.

2. The officers of an S-Corp are required to take a reasonable salary. This salary is subject to Social Security and Medicare taxes (15.3%) which would not normally be the case, so you've just increased your taxes paid.

There are other significant issues regarding property transfer upon death, basis issues at sale, etc that come into play as well.

Shane H. · Answer

@Roger Laughary

That is a good question. The only advantage I could think to choosing to be taxed as an S-Corp here in KS is the tax loophole Brownback passed earlier in his term. However I think that typically would have a greater affect on higher income earners or those who are fully self employed.

My understanding of the advantage of the S-corp taxation now (I think you can set up an LLC and choose to have it taxed as an Scorp here) - is the tax benefits.

So say you are a self employed house flipper or self employed contractor. You will make $200k in profit.

If you elected to be taxed as an S-Corp here you can say pay yourself what the taxing authorities would call a "reasonable" salary let's say $50k for simplicity sake. That salary is taxed at the full slave rate of someone who exchanges their time for money in lieu of earning it by investing. You could take the remaining $150k as a distribution which would be taxed at a far lower rate and per my understanding Im thinking with the KS tax law change you were even allowed to pass that distribution through with no taxation on it at the state level. (Many who were reaping the benefits of this KS tax law change were complaining that they weren't paying enough believe it or not -- if you read the Wichita Business Journal or the Eagle you've likely seen articles to that effect)

You can get a better understanding of it if you find the article the Eagle had a year or so ago relating to KU basketball coach Bill Self taking full advantage of the tax code change. I dont think Gregg Marshall at WSU took advantage until recently - I noticed in the Bus Journal he transferred the deed to his house to an LLC he set up so I'm assuming his accountant finally got with it and he set up an LLC taxed as an Scorp to take the payments from the school in lieu of them paying him directly.

Disclaimer - I'm not a tax professional - simply a guy who likes to read and attempt to understand the nuances of the tax code. So do your own homework but that's the gist per my understanding.

As for the KS tax issue - I'd look for that to change with the next administration unless Charles Koch is able to get his own puppet elected which is very well possible. He and his shell companies masquerading as non profits have the money/power to do it. Brownback vetoed a bill to override the changes just recently - I dont think the House/Senate have enough votes to override the veto to raise the rates back up at the moment.

Steven Hamilton II · Answer

Yes, I'll be posting it here on BP's blog.

Linda Weygant · Answer

Pretty much all of my answers surrounding tax questions and entity structure question on this forum are "It Depends. There is no cookie cutter, one size fits all approach." If I could figure out how to program that as a macro, I would.

Steven Hamilton II · Answer

Because your friend didn't come shot someone with competant knowledge of real estate and taxation.

There was a recent topic on this and I'm writing a detailed article on the topic right now.

Tim Greenfield · Answer

@Roger, I am actually in the process of setting up an LLC. Has anyone suggested having an overarching LLC and then having each of your properties in an individual LLC under the overarching one? A friend had mentioned that this added additional liability protection. Just looking into it myself. I am a high earning W2 with 4 buy and hold in different states and I am planning on steadily adding to this.

Shane H. · Answer

Linda would you agree that ideally the right business entity really is an answer of "it depends" on the persons situation? I'd guess there are times when an S-Corp structure is more advantageous as I pointed out above if I was correct in my scenarios/assumptions and as you pointed out an Scorp is not the best solution for your example scenario.

Good info on point #1 - something I was not aware of.

Shane H. · Answer

@Steven Hamilton II looking forward to the article. Will you post it here and is there a way to sign up for an alert of some sort when you publish it? Would love to read it.

S Corp Instead of LLC for Rentals?

S Corp Instead of LLC for Rentals?

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