LLC declare as Partnership or S-Corp?

Question

I have a new LLC. My prospective accountant has suggested that I declare it as an S-Corp. Would the income automatically pass through in an S-corp, to the members of the LLC? Is this good or bad, pros and cons? What are the cons to declaring S-corp vs declaring Partnership status? What are the pros? I have to decide this month, before the end of the year, in order to make it easier to do my taxes on the 2 new properties I acquired this year. But I don't want to make the wrong decision and regret it later. Any input, advice, knowledge, on this is appreciated.

Chris Soignier · Answer

It's impossible to provide good advice on what election to make w/o knowing more about the activities, ownership structure, investing goals, etc.     In general, partnership elections are preferred for passive investments, and each investor is allocated a portion of the LLC's income/(loss) relative to their ownership %.

S-Corp elections can be helpful when you have a lot of earned income, so you can pay out some of the profit as distributions, avoiding the ~15.3% self-employment tax that would be due if those amounts would be paid in salary.

Lastly, C-Corp elections provide some incremental opportunities for business deductions, and are apparently the least-most audited structure.

I have a series LLC w/ an S Corp for my rehab company, a C Corp for my marketing company, and I'll add a new series for each rental property I may acquire outside of my retirement accounts.

Account Closed · Answer

@Jon S.

Ill take a shot at it.

Your rental income is passive by nature, so there in no requirement to pay self employment tax  on it.  The partnership will have no bearing on your taxes, in other words it will allow your income to pass thru to you as passive income.

In the flip side, your flip income is considered active income and therefore subject to self employment tax.  An approach to minimize some of the self employment tax is to pass some of that flip income to yourself in the form of a dividend.  The LLC taxed as an s-corp provides you that opportunity.

Brandon Hall · Answer

@Jon S. Run away from your prospective accountant and don't look back. Unless he/she gave you a really, really good (read: unique and rare) reason to utilize an S-Corp after you explaining your current holdings, that accountant is clueless when is comes to real estate. So unless they offered up a really good and rare reason for the S-Corp, move on to the next accountant. Curious, was he/she a CPA or EA?

As the gentlemen above me have correctly stated, flips should utilize an S-Corp if the annual net profit is >$40k. Rentals should utilize an LLC if any entity at all.

Rentals should not be held in a corporation unless for strategic tax/estate planning or enhanced liability protection. When you go to move a rental from the corp back to your name, it's a taxable transaction. Plenty of other reasons, but that's a primary one. Just less flexibility and more scrutinization and headaches.

Brandon Hall · Answer

@Jon S. what type of business are you in? Are you generating earned income? If yes, is the expected net profit going to be at least $40k?

Jon S. · Answer

Thank you Dave. Can you elaborate, why is the S corp  better for flipping? And why is the partnership better for rentals? Thanks!

Dave Toelkes · Answer

As a general rule:

If your LLC is flipping properties, then S-corp is probably the better choice.

If your LLC is a residential rental activity, then partnership is probably best.

Both tax treatments pass the net income or net loss through the LLC to the individual members/partners.

Chris Soignier · Answer

@Hiron Fernando , I'm not a CPA or attorney, so please verify my opinion w/ a professional.   IMO, for rentals, you don't need an S or C Corp. election.   W/o one in any given series. that series is a pass-through entity.  That's how all my MF investments are structured, and it works ideally for our needs.

Hiron Fernando · Answer

@Chris Soignier thanks for this explanation. I too have a series LLC in which I create a new series for each property I purchase. All properties are under the parent company, which is an LLC. I am currently doing my taxes to where all my income is reported on my personal taxes. I have heard about doing your taxes on the LLC as a business return and passing through all the income over to your personal return. I believe this is done for better protection (so rental income is not showing on your personal tax return).

Am I thinking of this correctly? I only do rental property work (no actively earned income). Do I need to file my business return as a S-Corp (for tax purposes) and pass through that income to my LLC?

Any help would be appreciated!

-Hiron

Jon S. · Answer

Brandon, I'm not sure how to answer that. This year I acquired and renovated my first two properties. The first one is generating $28,800 rent (2400/mo), and i expect it to net about $12,500 in 2016. Deductions will be $200/yr taxes, $1050/yr insurance, $4000/yr utilities. Maint should be very low because it had a very complete renovation, say $1000. That leaves $22500. Mortgage payments will be about $10000/ yr until i get refinanced. That leaves $12500. There are also payments on credit cards that i used to do the rehab, can the payments on credit cards be counted as expenses, or just the interest? Vacancy should be low because it is rented by an agency for the tenant. I'm not sure what other deductions I will be allowed, ie, depreciation, etc.

The 2nd property is a triplex, and i expect it to have rents of $48600, and yield about $15000/yr in 2016.

In 2016, and each year thereafter, I hope to buy 4 more properties per year, all buy and hold rentals, all BRRR. If I do some flips, which I might also do, I can open a second LLC for the flips.

So I am intending to build a large portfolio of buy and hold rentals. Eventually my profit will exceed $40K. However, I don't think it will in 2016.

LLC declare as Partnership or S-Corp?

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