Is a S-Corp the Best Choice for a Real Estate Company?
Question: I have a real estate development company. I was told to form a S-Corp. Is this right?
Response: Who told you a S-Corp was better for anything? I would suggest exactly the opposite. You NEVER want to have real estate in ANY corporation. EVER. NEVER. PERIOD.
A LLC gives you the option to select the method of taxation that is best for your particular situation. OK, so let’s say you decide that for some quirk of fate that S Corp taxation is better than any other method. You can elect to be taxed under S-Corp rules.
LLC’s are typically taxed as partnerships if there is more than one owner, and a disregarded entity if only one owner.
Many tax preparers and attorneys love S-Corps. They think that they can pull a fast one on the IRS. Let’s say the company earns net income of $ 150,000. If you are a sole proprietor (not incorporated), the entire amount is subject to self employment tax, as well as income tax. But what if you were a S-Corp, and you took a salary of $ 50,000. How would that be taxed? Only the salary would be subject to self employment tax. (the entire amount is subject to income tax, but that which is not subject to self employment tax under $ 120K. So, you would save 15% of 120K — 50K = 70K x 15% = 11K in your pocket) Sounds like a wonderful tax shelter to a lot of people. Never mind that you are shooting yourself in the foot for social security benefits later….
Here’s the problem. Suppose that you are the one that’s earning the income, by doing real estate sales. You are the company. The IRS looks at this and says, whoa, the entire amount is subject to self employment tax. Wham! Bam! Tax shelter implodes.
For many years, they didn’t seem to touch this obvious tax dodge. In the last few years, they have. There have been numerous tax court cases where the IRS has basically prevailed under the theory that if you earned it, it’s self employment income. So that tax dodge is pretty much been attacked.
So, here’s my take on it: a S Corp has only minimal benefit from a tax saving standpoint, and only in certain specific instances. Those who try the “minimum reasonable salary” thing are ill-informed and not up to date on the latest tax court cases.
But there is one other thing about S-Corps that is a killer for most businesses that have any real estate. When and if you dissolve the S corp, any assets left over which are distributed are taxed at fair market value. So let’s say you have some land you don’t develop or wholesale, you end up holding one lot. You dissolve the S Corp. The land and any other assets are considered given to you as a “deemed sale” — you pay taxes on it as if you had purchased it at fair market value. Double Ouch! Ok, if all you have are some old furniture, no big deal. But what if you have some land which has appreciated? Anytime you take any non-cash asset out of the S Corp, it’s considered a deemed sale.
If you have a LLC taxed as a partnership, this does NOT happen.
So, find yourself a good CPA who is up to date on the ins and outs of S Corp versus Partnership taxation. Hint: most tax preparers prefer S corps because the law is much simpler and it’s easier to deal with S corps. You will run across people who think S Corps are the answer to any tax problem. Avoid them. Those of us who study this stuff extensively generally prefer partnership taxation. It’s much more flexible.
