Moving Rental Properties to Corporation

[Syed A.]

Hello BP Folks,

I am new to the forum and need some advice at this juncture. I am computer engineer by profession and started the real estate investment around 2 years back and purchased 8 rental properties mostly townhouses in the Chicago suburb. Overall, I am doing property manager job for my personal properties as well. right now all the property title is on my personal name and i wants to take that out to corporation. I wants to run like a business since I wants to add 1 property every month in my portfolio.

I need advice & guidance from gurus & my seniors here? I opened the S-Corp around a year back and I am creating ALL the tenants leases on my s-corp and not on personal names. every property already has liability insurance. I have separate business accounts for real estate business. so its 100% separate entity to day to day transactions. All the incomes and expenses are running through business accounts.

In order to grow my business, what should I do next ? Should I transfer the property deeds to S-Corp or LLC and grow the company? I wants to address 2 major concerns. 1) Liability protection 2) Tax Savings both are important.

Issue #1: Eligibility for S Corporation Treatment: I have been told that Loss of eligibility can occur if the S corporation receives too much passive income. so in my case I am creating rental leases on my S-Corp name and not on my personal name. is that OK or my S-Corp is in trouble?

Issue #2: S-Corp VS LLC: My accountants are telling me that S-corp is better for tax purpose and my attorney is telling that LLC is better for liability protection. so who's correct here? As the argument goes, the S corporation can establish a salary or bonus for its stockholder-employees, and pay social security and medicare taxes only on the salary or bonus.

Issue #3: Exceptions to Passive Loss Rules, We are the high earner couple over $150K AGI so we are getting ZERO tax deductions for rental losses. There are only two exceptions to the passive loss ("PAL") rules:

a) qualify as a real estate professional ===> for that, someone needs to spend over 500 hours actively managing properties. whats the guidelines here?

b) Income is small enough that you can use the $25,000 annual rental loss allowance=>> NOT Applicable in our case, AGI is over $150K

Thank You for ALL your time and help.

[Linda Weygant]

S-Corps are not intended to generate passive income.  If 20% or more of the revenue in an S-Corp comes from passive sources, the IRS can choose to disallow the S-Corp and convert to a C-Corp.  This becomes problematic in many ways and is beyond the scope here.

Additionally, S-Corps have issues with rentals when there are mortgages placed on the properties due to losses in excess of basis that can occur in this scenario.  

If qualifying for additional mortgages is your main concern, then I'm not clear why your broker is unable to use your rental income to qualify you.  

There are some techniques to convert your rental income into W-2 income, but bear in mind that you are taking income that is not taxed for self employment taxes and making it taxable.  So you're now paying a 15.3% tax that you normally would not have to pay, just to qualify for additional mortgage that you should be able to qualify for anyways.  So just tread lightly on this because, on the surface, it makes no sense.

In any case, here's how you do it.

Create an S-Corp whose charter is Property Management.  You'll manage the properties through this S-Corp.  You'll charge each of your properties a management fee and actually transfer money into the separate corporate business account.

From the S-Corp, you'll pay out general business expenses such as telephones, internet, office supplies, meals, etc.  You'll then pay yourself a wage from the S-Corp.

As I mentioned above, this is an expensive way to convert to W-2.  Additionally, as soon as your mortgage broker realizes that you own the S-Corp, they'll see that it's self employment income and make you just through additional qualification hoops anyways.

Not a setup I would recommend unless you have hugely extenuating circumstances that make it necessary.