Which To Choose: LLC or S Corp

Question

Hey, Bigger Pockets Family!

I am just getting started in my real estate investing journey and working to lay a solid foundation in wisdom and knowledge. I believe it is wise to develop a general (if not thorough) understanding of what I am getting involved with. I am currently reading through Brandon Turner's Rental Property Investing and have a few others. In light of tax season, I felt it would be a good idea to seek out guidance, insight, and wisdom to be prepared for next year's taxes. I have come across (like many of you) conflicting information. I have read about people having numerous bank accounts, 6+ LLC's, putting properties right into a Trust, operations LLC, creating an LLC but taxed as an S-Corp, etc.

I am very confused as to where to start. My initial plan was to create an LLC and then I started to do some research and came across a former IRS agent who has a YouTube channel sharing a plethora of information. Although premature, I felt an S-Corp was going to be my ultimate goal. I wanted to start to plan and prepare now to have a clear vision to ensure I am working toward my goal. Now tonight I have recently learned that an LLC can be set up and taxed as an S-Corp. This all sounded fantastic until I read that information here on Bigger Pockets that conflicted with the aforementioned desires. I have also looked into a Series LLC, but my state does not currently offer them. I believe the wise decision would be to set up the entity in the same state as the property. If anyone is willing to shed some light as to where to find a CPA who knows real estate, or a tax lawyer,  a tax strategist, or is able to connect me with someone of that nature here on Bigger Pockets that would be fantastic. Thank you in advance!

Tarl Yarber · Answer

I am not a Lawyer, or a CPA.  I am only giving you my opinion based on my experience.

When I started, I used an LLC for liability protection.  This was considered a dis-regarded entity so the IRS considered me a sole-proprietor for taxation.  Once I started making grown up money in real estate, I got a solid CPA whole told me to take my LLC and elect it to be an LLC taxed as an S-Corp.  The reason the CPA wanted me in an S-Corp was because i flipped houses, and that was taxed as ordinary income.  An S-Corps main purpose for taxation was to help me avoid Self-Employment tax, which I was paying due to my dis-regarded LLC.  I asked when should anyone consider switching to an S-Corp, and the answer at the time was once you are making over 50k Taxable income a year through that business.  WHY?  Because anything less, then the amount you pay in filing corporate returns, issuing a W2 to your self, and employment tax (all required with a S-Corp), is more or equal to just paying the self-employment tax.

Keep in mind, this was all for FLIPPING houses, not for holding them.  I do not keep any of my rentals in a S-Corp.  All of this was many years ago, and our entity structure is MUCH more elaborate now and pretty ridiculous at times, but I have earned that ridiculousness over the years and the assets we have accumulated and businesses we have started.

Bottom line, LLC's in my opinion are great for liability protection PLUS make you look more like a business, and not a hobby.  Separating your personal bank account from your real estate business is also key long term, no co-mingling funds, very naughty.

Final thoughts: Attorneys do not think CPA's can read, and CPA's do not think Attorneys can do math.  Very rare you find an attorney AND CPA that agree on the exact same strategies.

Arlan Potter · Answer

Account ClosedWorry about it when you get 50 properties, or 100.  Have good commercial insurance with adequate liability coverage. Neither organizational form will save taxes for a rental property owner. I did set up three LLCs when we started buying some small apartments. One LLC for rental homes, one for multifamily, one for commercial. We already had over 50 single family homes.

Like it or not most people never start buying investment property so the organizational structure makes no difference.

Eamonn McElroy · Answer

Account Closed

Focus on making money first.

When you're making good money, get a good tax CPA/EA on your team as an external partner to mitigate your tax burden and plan.

If you don't own any rental properties and haven't done a single flip you shouldn't be thinking about LLCs and S Corps...

My two cents.

Get that train moving before you start thinking about what color to paint it.

Account Closed · Answer

@Tarl Yarber

Thank you so much for that insight. After reading your response I feel as though I am on the right track. Leaving out the intention of flipping 2-3 houses this year and trying to find and buy two 4-plex's is ideal. However, I want to start off flipping houses but wanted to be wise with the way I set things up initially so it would feel like a waste later as I grow. I do have a business bank account with money just sitting there until I am able to figure out what I will do to get started. I am currently trying to find a good solid realtor to start working with. I felt starting an LLC may have been premature initially, but I felt that paying those fee's would make me look like a legitimate business.

Again, thank you so much for sharing your thoughts with me!

Andrew Sponsler · Answer

@Scott Smith Thanks for your post! That is a great conceptual beginning to my newbie understanding of asset protection.

Scott Smith · Answer

When meeting with clients the first order is to discuss (A) their personal assets, (B) break down their current investments portfolio and other business ventures before discussing any (C) future goals. Each of these variables will dramatically change the advice for the individual asking this question. I often break it down into the "five pillars" of protecting your assets.

1st pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments - these simple steps will help you prevent lawsuits before they even occur.

2nd pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

3rd pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property they can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE- check out this article to learn more. (CA investors can look into the DST)

4th pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

5th pillar is owning everything anonymously. If people don’t know what you own, then they are less likely to sue. People don’t sue people that qualify for food stamps. This anonymity can be accomplished for free by using Trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner still, it doesn’t matter because you are not the owner. The trust and the LLC are the owner of the asset/real estate, so even in the scenario that they guess, they guess wrong.

To understand some basic differences between corporations, you can also check out this link. In your situation it would be very beneficial to make connections with experienced professionals who can give you guidance on how to structure these entities. If you structure them right from the beginning rather than DIY, you end up saving a lot of headache.

This isn't legal advice, just my opinion as a real estate investor.

Tarl Yarber · Answer

Account Closed

no problem! happy it helps.  What state are you in?  LLC's can be expensive depending on state.  You can always wait to file/create one officially until you are close to finding a property.  Depending on the state, it may not be hard to file for one quickly.

Account Closed · Answer

@Tarl Yarber I live in (southeast) Pennsylvania.

Account Closed · Answer

@Eamonn McElroy

Thank you for your insight! I failed to add int here that I do have a property that I should be closing on this month as a flip and plan to do at least two more this year as well as buy two multi-family 4-plex units.

Eric Mayer · Answer

You don’t need an llc yet and it would limit you on residential financing. I would put the property in your name and get an umbrella insurance policy to protect your assets.

Eric

Which To Choose: LLC or S Corp

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