Why You Shouldn't Invest in Real Estate through an S Corp: The Debt Basis Dilemma (2024)

FAQs

Why You Shouldn't Invest in Real Estate through an S Corp: The Debt Basis Dilemma? ›

In an S Corp, your ability to claim losses against your investment is restricted to the actual money you've invested in the property — nothing more. In the event that the property generates a loss, you can only offset this against your 'stock basis,' which is essentially the money you've put into the property.

Basically, S-corps are a bad option for real estate because when an asset is placed in an S-corp, it is stuck there and cannot be taken out without paying capital gains tax. Owners are forced to pay this tax at the end of each tax year without an option to defer.

For tax reasons, you are generally well advised not to hold real property in a corporation. LLCs and revocable trusts are usually better alternatives. But there's one scenario where using an S corporation to own property can pay off tax-wise.

For some real estate investments, it is highly recommended to use an LLC and an S corporation at the same time, with the LLC holding the property and the S corporation managing the business. This strategy shall offer real estate investors both the asset protection of an LLC and tax benefits from an S corporation.

Stock ownership restrictions.

An S corporation can have only one class of stock, although it can have both voting and non-voting shares. Therefore, there can't be different classes of investors who are entitled to different dividends or distribution rights.

Having the S corp own your residence may sound like a great way to get free housing, but it's likely to attract attention from the IRS. Whether you are the only shareholder or one of many (up to the limit of 100 allowed) living in a house owned by the company is reasonably construed as income.

Investors often use holding companies or LLCs to reduce personal liability and legal risk. Additionally, through a holding company, investment property owners are open to more tax benefits and ease of management compared to other legal entities. For instance, you can use many legal entities to protect your business.

LLC. A limited liability company (LLC) is a common entity choice for real estate investors and offers many advantages. Choosing this structure for your real estate investment business allows you to limit your personal liability in the business to the money you contribute and the debts you co-sign for.

If your home has appreciated in value since you bought it, you can get both some tax-free income using the $250,000/$500,000 exclusion and a step-up in your depreciation basis by selling your home to your S corporation. (This is the new S corporation you will create when you finish reading this article.)

Transferring a duplex from a dissolved S-Corp to an individual, in this case yourself as the sole owner, typically involves filing a deed in the county where the property is located. This deed, often a quitclaim or warranty deed, should be executed from the corporation to you personally.

Is an S-Corp good for rental property? ›

Establishing your rental business as an LLC or S-Corp protects your personal and business assets from common liabilities, such as credit issues and lawsuits. LLCs and S-Corps also enjoy certain tax benefits that lower your tax responsibilities, allowing you to keep more of your rental income.

If you earned $100,000 (net) as a sole proprietor real estate agent, you'd pay 15.3% on the full $100,000 ($15,300). But, after forming an S-Corp, you pay yourself a salary of $50,000 and only pay the 15.3% tax on your salary ($7,650). In this example, forming an S-Corp halves your self-employment tax liability.

“In my opinion, LLCs are your best option for owning real property, as they blend the best aspects of partnerships and corporations. With an LLC, you don't own the property, the company owns it, protecting you from much liability.”

LLCs and S corps have much in common: Limited liability protection. The owners of LLCs and S corporations are not personally responsible for business debts and liabilities. Instead, the LLC or the S corp, as the owner of the business, is responsible for its debts and liabilities.

It can be difficult to raise cash through a stock offering because an S corporation can issue only one class of stock, which must have identical rights regarding dividends and the distribution of company assets if the business is light can be difficult to raise cash through a stock offering because an S corporation can ...

The Advantages of LLCs

In addition, it is not necessary to hold formal shareholder meetings and maintain annual minutes for LLCs. LLCs provide more flexibility than S Corps. For S Corps, there are pro-rata requirements for items of income, loss, or distributions.

But can't an estate hold the S-Corp stock and remain eligible? The good news is that an estate itself is an eligible S Shareholder, therefore it may own the S-Corp stock throughout the period of the estate's existence, which lasts during the administration and settlement of the estate.

It can be difficult to raise cash through a stock offering because an S corporation can issue only one class of stock, which must have identical rights regarding dividends and the distribution of company assets if the business is light can be difficult to raise cash through a stock offering because an S corporation can ...

As a return, taxes are assessed at each taxpayer's individual income tax rate instead of the rate of a rental property business. Some investors prefer to create an S corporation for rental properties to limit their personal liability in a rental situation and reduce costs at tax time.