Money-saving entity selection and strategies are not based on arbitrary guess work, but on factual data by examining the three sides of an entity – the LEGAL side governed by state law – the TAX side governed by tax law – and the IRS side governed by statistics as to which entities are audited the most or the least.
So logically you want to select the entity that has the BEST of all three sides:
- Legal limited liability protection
- The best tax-saving benefits
- The lowest IRS audit profile
For real estate the best strategy is an LLC elected to be taxed as a partnership, one entity – an LLC-Partnership.
The Pitfalls of C-Corporations for Real Estate
C-corporations have many tax pitfalls for real estate, such as double taxation, the inability to deduct losses against your 1040 income, higher IRS audit profile, penalty taxes, and more. However they have the big benefit of special tax-free deductions (and savings) that other ownership forms do not have.
The best way to reap this big benefit, yet avoid the above pitfalls, is to make the C-Corp a 2% minority member of your LLC with you (and maybe other individuals) as the 98% majority member(s) creating the LLC-partnership – the ideal entity for real estate.
AVOID S-Corporations Like the Plague
S-corporations are commonly and ineptly recommended as an entity for real estate by many attorneys, CPAs, and speakers on the circuit – all who have not done their homework – as S-corps are an IRS Audit Red Flag and Tax Disaster for any type of real estate – both keepers and flippers. More specifically:
- S-corps are more prone to costly IRS audits and even costlier constant tax court litigation where the taxpayer almost always loses! They are the most IRS litigated entity.
- S-corp owners are required by IRS to be paid highly taxed W-2 salaries along with “garbage” employment taxes and payroll filings.
- There are S-corp limits on deducting losses against your other income (It is not a total flow-through entity, so there are more lost savings).
- Tax-free refinancing could be taxable through an S-corp (a huge loss in savings).
- Other costly drawbacks.
The Best Entity for Real Estate: A Properly Structured LLC-Partnership
An LLC-Partnership does not have these expensive pitfalls of c-corps and s-corps. This is all fully supported by tax law citations which the above (most attorneys, CPAs, and speakers) do not have a clue about. So avoid them too!
For real estate, another entity choice to avoid is a single member LLC with one member – you. Legally it gives little or no protection of your personal assets. On the Tax/IRS side, single member LLCs file IRS schedules C or E, the most audited schedules.
The best entity for real estate is a properly structured LLC-Partnership as it avoids the these detriments.
[The above article is an excerpt from the author’s asset protection system specifically for real estate investors – The LLC Master Machine.]