10 Reasons NOT to Use Corporations for Real Estate Ownership

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One of the big questions often asked on real estate forums, especially by new investors, is do I need to incorporate to buy real estate? There are plenty of compelling reasons to use a corporation when going into business, but buying and owning real estate may or may not be one of them.

The use of a corporation will often come down to personal preference and risk tolerance. It is unfortunate that today many investors are scared into the need of a corporation after listening to speakers at real estate events or their local real estate investor clubs. They are often pitched do-it-yourself kits or options to have company set up all of your legal entities for you. Fear should never be an underlying reason to incorporate.

Any real estate investor choosing to incorporate and operate as a business should carefully consider all of the pros and cons and should definitely consult two legal opinions at a minimum. Make sure you are clear on why or why not you would want to use a corporation.

Here are 10 good reasons to avoid using an entity when making your decision!

BONUS Reason #1: Don’t do it out of fear.

I am going to address this right off the bat as a bonus and then lay out 10 practical business-related reasons below. For as long as I can remember, fear has been the number one reason for investors to incorporate and use complicated strategies to operate their businesses.

Why? Because fear sells! And those who propagate fear usually have something for sale. It simply helps to boost the bottom line numbers when you can scare the crap out of everyone.

Investors should never operate and make decisions from a standpoint of fear. Real estate is a logical business that can be profitable when investors are slow, methodical, and take the time to listen to good advice.

With that being said, fear is always used to entice investors to make irrational and quick decisions: fear of being sued, fear of losing everything, fear of going to jail. Each of these fears is used to sell investors on why they need to use corporate structures to invest in real estate. Oftentimes, as you will see below, that is not the best strategy, and the real estate investor has very little to actually be afraid of. It is certainly nothing that cannot be mitigated in other ways without making the mistake of using a complicated strategy.

If you feel yourself being sold on fear, stop and think. Get the advice of tax professionals who have nothing to sell. Those whose only motivation is to answer your questions will always be your best guide.

So, now that we cleared that up, here is the list.

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Related: Can I (and Should I) Move My Property Into an LLC and Out of My Name?

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10 Reasons NOT to Use Corporations for Real Estate Ownership

Corporations are more audited than partnerships.

Corporations (C and S) are audited more than partnerships, and corporate audits are on the rise. For instance, corporations are fairly frequent targets on the issue of reasonable compensation (discussed in number 4 below).

This reason alone should be enough to make any real estate investor think twice before deciding to use an S or C corporation, which are both very popular choices by investors.

Dealer status can be costly.

Corporations are designed for active (ordinary income) businesses. Thus, using a corporation (C or S) for quick-sale flips is a blatant admission of costly dealer status and impairs dealer-avoidance planning.

In layman’s terms, there are additional taxes and fees and possibly even licenses that must be obtained if you are categorized as a dealer.

Corporations are subject to more payroll filings.

Corporations (C or S) are subject to more payroll filings because corporate shareholders are employees and must receive a reasonable W-2 salary. In the case where there are annual tax losses in the corporation, a W-2 salary could cause unnecessary taxable income to shareholder-employees. How costly!

The IRS may scrutinize “reasonable compensation” to C or S corporation shareholder-employees.

Reasonable compensation essentially means that the combined amount of wages and fringe benefits cannot be disproportionate in relation to the value of the work being performed.

In reality, this is minor and not one of the top line items that is going to garner IRS scrutiny. That is, unless — and this is where it gets tricky — they see a company trying to play with the income they are reporting to improve their numbers.

Whether a company is or is not, this is simply one more area of scrutiny that comes with choosing a structured corporation like a C or S corp.

There are limits on deducting losses.

One of the unique, magical virtues of real estate investments is that a property can be showing a “paper” tax loss, yet still be financially profitable with positive cash flow. Corporations (C or S) have limits on fully deducting rental property tax losses.

Keep a close eye on this reason and use a trusted advisor and CPA to help you get the right answer based on how you are going to file. Realize that depending on the type of investing you are doing, this could play a key role in how you structure.

Example: Assume a property is held in a C-corp, and it generates $20,000 of bottom-line tax losses. If the owner is in a 31% tax bracket, they would lose $6,200 of tax savings!

Your corporation could make a refinance taxable.

S-corporation distributions of tax-free borrowed money to shareholders could end up being taxable income because of the above basis limitations of not including third party debt. That is, the rule in number 5 above could make a tax-free refinance taxable!

For many investors, the use of structured debt is a strategy to enable an investor to buy, renovate, refinance, and repurchase.  Under certain scenarios and with certain structures, each time you refinance could become a taxable event, leading to waste.

Your corporation could make distributed property taxable.

With corporations (C or S), there is taxation on distributions of appreciated property deeded from the corporation to the shareholder, even though no cash is realized.

Again, for some, the point of purchasing real estate is to build assets. If those assets are distributed to shareholders, even though no cash has traded hands and there is no actual cash advantage to the investor/shareholder, that distribution creates a taxable event. Not ideal!

Your corporation could make corporate liquidation taxable.

With C or S corporations, there is taxation on the liquidation of the entire corporate entity (with appreciated real estate) even though cash may not be realized. With real estate, you need tax-free exit strategies. You will not get this with C or S corporations.

Your corporation could make conversion to an LLC taxable.

With C or S corporations, conversion of the corporation (with appreciated assets) to an LLC will result in tax liabilities, even though cash may not be realized. You therefore need to plan your tax-free exit strategy in advance by not putting real estate in corporations in the first place.

Related: Yes, You Absolutely SHOULD Use an LLC to Invest in Real Estate: A Counterargument

Hopefully, you are starting to see the pattern here.  There is much, much more to think about than just “should I or should I not incorporate?”

Your corporation could make property transfers to another corporation taxable.

Transfers of appreciated property to a corporation (C or S) is taxable if the contributing shareholder is not in control of the corporation immediately after the transfer. This could be a tax dilemma where there will be a more than 80% change in owners after the incorporation.

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When to Use S Corporations

I think of using S corporations if my real estate strategy is wholesaling, flipping, rehabbing, or any real estate strategy that gives you money without you holding the property for investment. These types of strategies typically are considered active real estate strategies and generate active real estate income. Therefore, they are subject to self employment tax.

The benefit of an S corporation is that you can pay yourself a salary on a portion of your income from your real estate strategy, and the rest of it will not be subject to self employment tax. Only salary is subject to self employment tax.

For example, if I purchased a property and rehabbed for a $100k profit, I can pay myself a reasonable salary of $50k with an S corp LLC. The other $50k will not be subject to self employment tax.

However, if I earned this income through a SMLLC or Multimember LLC, the $100k will be subject to self-employment tax

I have been asked several times when speaking to investor groups how I hold my personal property. The questions almost always have the slant of fear. They come from investors who are mostly fearful of being sued rather than from the point of tax preparation.

For taxation, I have always relied on the professionals on my team. When I first got started, I held everything in my personal name and used layered insurance for my protective strategy. For my tax strategy, I eventually migrated my thinking with the advice of my CPA and have used an LLC to hold my investments.

I only have one LLC to hold my properties, and as they are paid off, I have a strategy laid out to put those properties into a trust.  My strategy is as my investments become more valuable, my reliance on corporate structure grows.

However, as a long-term, buy and hold investor, I have shied away from using a C or S corp for my entity structure for the above reasons. From a simplicity standpoint, this has made sense for my strategy and served me well.

Investors: Do you use corporations in your real estate business? Why or why not?

Let me know with a comment!

About Author

Chris Clothier

In 2005, Chris Clothier (G+) began working with passive real estate investors and has since helped more than 1,100 investors purchase over 3,400 investment properties in Memphis, Dallas and Houston through the Memphis Invest family of companies.

11 Comments

  1. This article I must take exception. I owned nearly 300 units in several states with my former wife(now deceased). We became targeted and scammed by others who were in the real estate industry and it started by them searching public record and finding out all of our holdings because we had it in our names. They even were able to obtain a 2 million dollar loan out of a national bank by structuring an entity and putting my name in it( without my knowledge or consent). Had my properties been in corporate entities that could not be traced to me I would not have been victimized.

    • Chris Clothier

      TLB –

      Thank you for taking the time to read the article and leave your comments. Two things stick out to me about your comments. One – you were not a new investor buying their first property. You owned over 300 units and secondly, at that point, you should have been using an entity with the guidance of legal counsel as I noted in the article above.

      At the same time, simply having property in an entity, would not have prevented someone from obtaining who owned the entity and may not have prevented them from opening accounts in your name. Simply having an entity does not afford that type of protection without going to extraordinary measures and spending quite a bit of money. However, at the point where you own 300 units, those are the types of measures you would take.

      Again, thank you for taking the time to coment. – Chris

  2. mark jones

    As a CPA I have problems with a number of things listed in the article. Individuals are audited more than S Corporations. S Corps are the lowest audited entity, less than 0.4%. Payroll taxes are only IF you have a payroll. Depending upon your profits as to wheither you need to have a payroll. I strongly suggest if people have questions about these items to talk to their tax professional.

    • Chris Clothier

      Hi Mark,

      Thanks for reading and writing your comments. I missed the advice of your CPA in my article although when writing it, that advice was there. I did note to seek two legal opinions as to whether or not you even need an entity structure and I absolutely meant to include the advice of a an experienced CPA and preferably one with experience working with real estate investors.

      The issues brought up in the article are ones that the average investor will not deal with unless they invite the issues upon themselves by not getting proper advice. I appreciate your taking the time to leave your comments and advice for investors on here.

      Best – Chris

  3. David Oberlander

    So Chris, please tell us which university you earned your law degree from and which state are you practicing law in? Inquiring minds need to know so we can avoid using lawyers from that school.

    This article is titled “not to use a corporation” but then you freely admit to using an LLC to hold property in?
    Do use understand what LLC stands for?

    Do you really believe an IRS audit is the worst thing that can happen to a business owner? Try surviving a “slip and fall” lawsuit where there’s no limit to the amount of damages or , as TLB pointed out, a really bad case of identity theft.

    • Chris Clothier

      Hi David,

      I am pretty sure I have never been to law school! I did go to college yet left before graduating to enter the business world and start my life as an entrepreneur. Soon after I built my first company and then my second and then my third…and so on. You get the point.

      So with the article, you have to strike up conversation on here somehow and often that means putting out your reasons for or against doing something. The article addresses new investors and should they or should they not use a corporate entity. There simply is not enough room or time to do the subject justice. However, I give the same advice to new investors all the time.

      If you are opening an entity out of fear, you need to consult a new attorney and as Mark pointed out above, a new CPA.

      I have owned real estate for almost 20 years at this point. Dozens of long-term investment properties and never been involved in a slip and fall lawsuit. I would never let the fear of one drive me to use a corporate entity. That is what I have layered insurance for and I am well covered should someone try to sue me frivolously.

      As for my use of entities, I began to use them when my business dictated I needed to. I was doing multiple different types of transactions and my leverage on my properties was shrinking. i.e. – I had more exposure to lawsuits due to wealth accumulation.

      So I structured my entity with the help of said lawyer and CPA so that businesses were separated and each could be properly maintained so the corporate veil could not be pierced. Then they were structured so that an attorney looking for a quick settlement would have to really put the work in if they wanted to sue me. They would have to work diligently to put the pieces together.

      Often times, new investors do not need the sophistication of an entity to invest in real estate and should focus on properly insuring themselves and their properties before turning to entities to hide ownership.

      I do appreciate you taking the time to read the article and create a little dialogue. It is how new investors are going to get both sides of the story to prevent them from falling for DIY and guru style sales techniques for entities.

      Best – Chris

    • Sylvia B.

      Well, David, do YOU understand what LLC stands for?

      LLC = Limited Liability Company

      A corporation is a company, but a company is not necessarily a corporation. One can hold property in an LLC without using a corporation.

      • Collins Hunsaker

        “A corporation is a company, but a company is not necessarily a corporation.”

        Legally speaking, a corporation is a corporation and an LLC is often referred to as a company. Typically, both should be used for some sort of “business purpose”. But that being said they are both distinctly different entities for state law purposes. One is definitely not the other…even “not necessarily” speaking.

  4. Allen Fletcher

    If I have a buy and hold portfolio and I work flips and wholesaling should I have two entities? From this article it looks like I should keep my buy and holds in an LLC and do all of my flips and wholesales in a C or S corp. Will this keep my taxes lower without all of the negatives?

    Allen Fletcher

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