Do I establish an S-Corp or an LLC???

Question

I understand (and please tell me if I’m misinformed on any of these assumptions)

I understand that an S-Corp might be the best legal structure if your business is rehabbing/flipping, wholesaling, or anything where you are activity acquiring a property and then selling it at a profit.

And that the reason for this has to do with more favorable tax laws for this type of work.

Compared to an LLC which is - as I understand - the way you want to set up a passive-income rental property.

And furthermore, I believe I have also heard that it advisable to have each rental property set up in separate LLC’s. I understand that the reason for this is to minimize any risk of being sued etc.

in other words, if someone broke their ankle on a particular property and they decide to sue, if the property is set up as is own LLC the plaintiff makes a claim against only that property.

As opposed to having all of ones properties under one LLC, this opens the landlord up to greater risk because in this scenario all the assets are under one LLC.

So my question:

Am I understanding correctly that if I do rehabs, flips and wholesale deals AND if I own any rental property, that I would want to establish an S-Corp for the rehab/flip/wholesale business and then create individual LLC’s for any other passive income rental properties?

Finally, I do realize that it’s possible to elect to have an S-Corp taxed as an LLC.

However, I’ve heard that still you want to have rental properties set up as separate legal entities apart from any active rehabs/flips.

Any knowledge on this would be greatly appreciated.

All the best

Andrew O.

David M. · Answer

@Andrew Oliveri

You are mostly right.

Aside from the name, S Corp is actually really more of a tax status than a legal entity.  So a Corporation, ie “C Corp,” or a LLC can elect to be taxed as a S Corp in which the owners need to be payed a reasonable salary and the rest of the profits are passed through (I believe as dividends).  This saves you on self employment taxes.

Correct in that you want to keep your long term holds separate from the your short term holds.  As you stated, it’s about limiting your risk for asset protection purposes.  Your short term holds are basically generating risk so why have them in the same legal entity as a long term asset.

The strategy to put every long term hold in a separate LLC is up for debate as you can read in here in bp.  It’s a matter of risk tolerance, cost, and logistical “headache.”  Having single family homes is different than say a single 10 or 50 aptartment bldg.  a bunch of single family homes can be held in a personal name and covered with insurance.  This let’s you take advantage of standard residential loans (which is what I do).

Also, what is your cost to creating and maintaining a LLC?  Each state is different.  Is it a single member LLC or multi -member?  In NJ I don’t need an operating agreement to have a single member LLC and I can file myself with like a annual $150 filing fee online (in NJ).  I hear about California having an annual $800 fee.  A multi member will need a good operating agreement— more money to have lawyer setup properly.  (If you have multiple memembrs, I guess the other way to go is partnership so you will still need operating agreement...).  Then there are filing the taxes... then, each LLC will need at least its own bank account...

Again, if you have 10 single family homes or three apartment bldg with 15units a piece it’s a different animal.  The former is might go with just two or three LLC and the latter each would have their own LLC.

Not to be negative, but you should do what you are comfortable and what you need.  You can make your life very “crazy” with lots of LLC’s, bank accounts, and lots of legal and accountant fees — and it MAY not be necessary.  Oh, even my own attorney felt I was smart keeping some properties in my own name since I can represent myself in

court.  If it’s in a LLC, the LLC is a legal entity (according to the State) so if I try to represent my own LLC in court I’d be practicing law without a license (being attorney isn’t in my ball of tricks).

Katie L. · Answer

@Andrew Oliveri

Couple more things to add here from a CA perspective, since CA tends to do things differently than the rest of the country.  In CA, most entities are subject to an $800 minimum tax.  This is PER ENTITY.  So having both an S-corp and an LLC, or having multiple LLCs, may mean paying the minimum tax multiple times.  This may not be a big deal to you if your main goal is asset protection, but if you are more concerned with cash flow, keep that in mind.

Also, while LLCs and S-corps (it is an LLC that can elect to be taxed as a C-corp which can elect to be taxed as an S-corp and not an S-corp that can elect to be taxed like an LLC/partnership) are generally pass-through entities, meaning the entity does not pay tax itself and income and expenses are reported on the owners' returns, S-corps in California are subject to a 1.5% tax.

The question you have posed is one you will want to discuss with a professional before making a decision.  One of the biggest differences between the LLC and S-corp for real estate relates to self-employment taxes, which might be what you are alluding to in your post.  But, there also are major differences in the taxation when property within these entities is sold or is distributed from the entity to the owner.  You'll want to weigh these alternatives and pros/cons before making a decision.

*This post does not create an attorney-client or CPA-client relationship.  The information contained in this post is not to be relied upon.  Readers are advised to seek professional advice.

Andrew Oliveri · Answer

@David M.

Thank you very much.

This was a very big help.

All the best,

AO

David M. · Answer

@Andrew Oliveri

(Typing on smartphone and wouldn’t let me keep going)

Any long term investments are passive income.  So, the S Corp doesnt but you anything

You want the different type of investments in separate legal entities for the sake of asset protection.  If you lump them together, you are just exposing everything.  Also, you may want different entities if you have different partners.  That being said, you could use one single member LLC, yourself, to be the owner/partner on a deal.  It should give you liability protection and provide some cleaner books.  For example, Oliveri LLC and ABC LLC create a partnership/LLC and do an investment deal.  Two legal entities are the owners or another entity which holds title to a property.

I’ve thrown a bunch of stuff at you (over a smartphone).  I hope it makes sense, and you get the gist of it.  Depending on what you are doing, there are many more permutations (some of which I can’t give any of my layman’s advice).  I hope my two cents helps.  Ask me any questions and if I’ll help if I can

Do I establish an S-Corp or an LLC???

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