Setting up a management S-corp for managing rental property owned by an LLC

[Nick Am]

I own a rental property through a single member LLC (say LLC-A) and I am in process of purchasing another property under the same LLC-A. Currently, I am self managing all the operations. LLC-A is a disregarded entity for tax purposes and I report the rental income/expense on Sch-E.

I want to setup a management S-corp (LLC-B) to look after the management of properties owned by LLC-A. For this I plan on charging 10% of rental income as management fees to LLC-A.

Some of the benefits of this vertical integration brought by LLC-B is:

(a) Ability to contribute to retirement plans (solo 401K, etc)

(b) home office deduction

(c) health insurance plan premium, among others. 

Some of the issues I have clarified so far from this and other forums:

1. Is juice worth the squeeze? --> Definitely. If the management fees stay in Sch-E, it is exposed to ordinary income both at Federal and state level, which is way higher than SE taxes of 9.55% (15.75-6.2 (personal social tax already maxed out)).

2. Why make passive rental income active and pay self-employment? --> Passive income doesnt mean tax free income. It is in fact taxed at much higher rate as ordinary income. 

3. Business justification of LLC-B --> This is can be a problem. However, I see this as a vertical integration and bringing more capabilities in house to make more money instead of hiring an outsider firm.

My question is such a setup valid? Has anyone done this without creating troubles with IRS? Can there be any issues due to business purpose of LLC-B? Want to hear opinion from the experts in the field here.

[Michael Plaks]

@Nick Am

You're making conclusions and, much worse, business plans from very limited and, in your case, completely wrong understanding.

Self-employment tax that you will pay on your property management income is not instead of ordinary income tax on rental income. It's in addition to this tax. So, by transferring income from a rental schedule E to a business schedule C you're creating a significant extra tax. You will owe more, not less, taxes.

Is it still worth it? Maybe, but not for tax savings. Maybe for a retirement contribution or for some other reason.

S-corp has no purpose at all in your case. Not going to give here a lecture on S-corps, but take my word: no benefits, only extra hassle and extra cost, such as preparing another tax return. As @Brett Synicky suggested, keep it simple, as a sole proprietorship.

You are also not considering that you will have to pay $800 per year and per LLC to your greedy state.

In short, get some professional advice instead of TikTok advice.