The RIght Structure - am I getting ahead of myself?

Question

Hi BP CommunityRob from Central NJ here.So I'm wondering if this question is a bit pre-mature considering I haven't bought my first proper investment property yet. I own 1 rental in a 55+ but it is occupied by my wife's family so therefore I have virtually no cashflow. (I should get credit for this BTW).My accountant highly recommended we set up an S-Corp and have 1 S-Corp per rental property we own (when we own them). I understand why he is saying 1 per property to reduce liability, protect all my assets, take advantage of the tax benefits etc. however this led me to so many more questions that I'm hoping I can find answers to:- Why S-corp over LLC - when I run my #s, I find it hard to make them work with additional S-corp registration and filing fees. Most of what I'm reading recommends an LLC for rental properties. I'm not sure I'm clear on what the benefits are of one vs the other.- I'm planning to finance my deals through bank loans should they make sense. I'm assuming I can't take out a conventional loan under a corporation and it must be in my personal name. If so, how do I move the personal loan in to the corporation so I am protected by the corporation?- What is best practice for setting up a buy and hold real estate business?- Do I need to think about this now or wait until I have a few properties under my belt?I look forward to hearing some ideas, strategies, feedback and input from the community. Thanks in advance for your help!Rob

Dan Schwartz · Answer

Tax advice (S-Corp vs Partnership taxation) is nationwide. Watch whose advice you take on BP regarding LLCs. They are regulated according to the laws of each state. Here in AZ, the lifetime cost of an LLC is only the one-time filing fee. $85....$35 if you choose not to expedite the filing. There are no annual (or other) paperwork requirements. My LLC bank account is fee-free based on the relationship with the bank (not that it's hard to get a free checking account). Tax returns are simple because the only income is the net from the property management company (a different LLC if mine) and the only expenses are mortgage interest and depreciation. That's an easy Schedule E. You can see that in AZ, when our lawyer says "put each property in its own LLC," we say "OK!" without hesitation. There is virtually no cost to do so. If we were across the Colorado River in CA, the hypothetical 20 LLCs mentioned above would cost $16,000 annually in CA Franchise Tax Board "existence fees" or whatever they call the $800 annual fee. I have no idea what the paperwork requirements are in CA. OP needs a new accountant based on the advice of taxing long term rental property as an S-Corp. But LLCs themselves vary state-by-state. Be sure to learn what happens in YOUR state, not someone else's.

David Dachtera · Answer

@Steven Hamilton II,Yes - the structure I described is intended for people in multiple thrusts. For example, doing both buy-and-hold and fix-and-flip / rehab.

Steven Hamilton II · Answer

@David DachteraI missed the co-owned part. and most of that post wasn't directed at you. A corp can be used for property management; however, for many that doesn't make sense to set up an additional entity for it unless they already have other activities.

David Dachtera · Answer

@Steven Hamilton II,If you go back and check my earlier post, I said "to hold properties in LLCs, channel money through an S-Corp".That answer's the OP's question directly, though incompletely.What part of that implies that the S-Corp owns anything other than membership in the LLC?Both entities are co-owned by a trust - no human person is a member of the LLC or a shareholder of the S-corp, and the LLC is multi-member to fortify it's protection capability.

Steven Hamilton II · Answer

You do not want a corporation in your ownership structure. @David Dachtera you can easily lose all of your benefits. Many of those attorneys can be sued for malpractice. You give up most of the benefits of holding real estate by using any kind of CORPORATION as ownership. A s-corp or C-corp should NEVER be involved.LOANS DO NOT COUNT AS BASIS IN A CORPORATE ENTITY. YOUR REFINANCE CAN BE TAXABLE. No step-up in basis for your beneficiaries. If you own real estate individually or through a partnership, your heirs may inherit the real estate at its fair market value when you die (this is known as a step-up). They can then sell the property without incurring any (or very minimal) capital gain. However, if you die owning shares of stock of a corporation that owns real estate, there is no step-up available for the real estate. The shares of stock will be passed on at their fair market value, but the real estate inside the corporation will not. If you heirs want to sell the real estate, they will either have to sell the stock of the corporation (which can be difficult—see item #5 above) or will likely incur double taxation if they sell the real estate separately.No debt basis for third-party loans made to an S-Corporation. Unlike partners in a partnership, S-Corporation shareholders do not receive debt basis for loans made by a third party to their corporation. The only way the shareholders can acquire debt basis is to personally make loans to the corporation. Even a personal guarantee of a third party loan will not give a shareholder debt basis. And since basis (both stock basis and debt basis) is the driving force in determining the taxation of distributions and the deductibility of losses, not receiving any debt basis from third party debt is a major disadvantage for S-Corporations holding real estate. S-Corporations cannot refinance their properties and distribute the proceeds to the shareholders tax-free unless the shareholders have adequate stock basis or debt basis. Since the shareholders receive limited tax benefits from leveraging the real estate inside an S-Corporation, this scenario is unappealing for real estate investors.

David Dachtera · Answer

@Rob Krin,I PM'd you...

Rob Krin · Answer

@David Dachtera - any assistance would be appreciated. thank you!

David Dachtera · Answer

@Rob Krin,You really want to talk to a business attorney. Accountants are good for what they're good for, but attorneys are more focused on the law.I can refer you to our tax and legal expert, if you like ...

Rob Krin · Answer

@David Dachtera - this makes a lot of sense. I'll need to talk to an accountant - not sure if I'll be using the one that gave me the initial advice even though his practice has been helping my family for over 30 years. Thanks for the advice.

David Dachtera · Answer

@Rob Krin,My investing group's tax and legal expert recommends to hold properties in LLCs, channel money through an S-Corp.That's the short answer directly to your question. The whole business entity structure question is a much larger picture.