2020 tax strategy for scorp with 5 rental properties

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2020 tax strategy for scorp with 5 rental properties

Mike Beall
Member since 2020 · 3 posts · 1 vote

I have read several articles here about the benefits of scorp vs llc and I'm going to work towards a series llc to hold the properties in 2021. In early 2020, I started a multi-member LLC (2 members) and elected scorp status. I have some questions about best tax strategy to minimize taxes for 2020. I have 6 properties (single family homes and duplexes) that bring in about $90,000 gross rent / year. My wife and I live in one apartment of one of the duplexes. Currently, I am running everything through my personal account (working on getting business account setup and accounting software) and mortgages/expenses are paid through that account as well. My questions are:

- My wife is property manager. Should I pay her a salary? I will have to pay payroll taxes on this money but it reduces the income tax-wise in the scorp. 

- With only $90k in income, can I get away with only doing distributions to the two members (wife and I) or is that a red flag (I know it is not recommended but it should be a small portion of the income after expenses)? It is a Virginia LLC. If I need to pay salary as well, what is reasonable?

- I have plenty of capital & rental expenses, and mortgage interest in 2020, so that will definitely offset the rental income but what is the best strategy to minimize tax impact here?

Thanks,

MikeB

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Dan Schwartz
Real Estate Investor · Tempe, AZ · Member since 2012 · 874 posts · 648 votes
5y

@Mike Beall huge red flag that you are organized as an S Corp, but paying everything through your personal account. 

You also only have a few business days left to sort out payroll for 2020, if you haven’t already.  

$90,000 gross is a relatively meaningless metric here.  The net profit is what you need to be planning on/for. 

Hope you can sort all of this out before it’s too late.  Good luck!

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  • Bob NortonPro Member
    Accountant · Slidell, LA · Member since 2019 · 382 posts · 272 votes
    5y

    @Mike Beall Am I understanding you that your LLC, electing to be taxed as an S-Corp, owns your 6 properties?

    If you elected S-Corp status with your LLC, then you will be taxed as an S-Corp and have to follow the S-corporation tax rules. This means that you will have to pay yourself a salary if you have income and take any distributions from your LLC. You also may end up paying capital gains taxes on your distributions if you withdraw more funds that you have invested in the LLC (your basis). Unlike an LLC taxed as a partnership or single-member LLC, you cannot add any corporate debt to your basis. So, the IRS treats any distributions in excess of your basis as a capital gain.

    Also, if you are living in one of the units owned by your company, then that is considered a taxable fringe benefit.

    And, if your S-Corp owns your rentals, then you cannot move them to another entity without paying capital gains tax including depreciation recapture.  This is called a "deemed" sale and you have to treat any dispositions of your properties, including distributions to you or another entity that you own, as a sale a fair market value.

    I recommend that you speak to your CPA before the end of this year to evaluate your situation.

    2Reply
  • Dan Schwartz
    Real Estate Investor · Tempe, AZ · Member since 2012 · 874 posts · 648 votes
    5y

    @Mike Beall huge red flag that you are organized as an S Corp, but paying everything through your personal account. 

    You also only have a few business days left to sort out payroll for 2020, if you haven’t already.  

    $90,000 gross is a relatively meaningless metric here.  The net profit is what you need to be planning on/for. 

    Hope you can sort all of this out before it’s too late.  Good luck!

    3Reply
  • George Mastrosavas
    Real Estate Agent · Strongsville, OH · Member since 2016 · 85 posts · 25 votes
    5y

    @Dan Schwartz HIRE a new CPA and FIRE your current COA if any. You need to operate as a business etc. Hope this helps!

    0Reply
  • Linda WeygantPro Member
    Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
    5y

    HOlding rentals in an S-Corp is a TERRIBLE idea in all but a very few niche circumstances.  Please consult with a competent tax advisor on this before you finish the hosing you are giving yourself.

    Podcast Guest on Show #244
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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    5y

    As others have mentioned, holding rentals (passive income) in a subS is bad move.  The main benefit of a subS is for Active/ordinary income pursuits like flipping, so you can pay yourself Some salary (subject to Ordinary income tax and self employment taxes) so the remainder of the income is not subject to self employment taxes....which does not apply to passive rental income.

    2Reply
  • Mike Beall
    OP
    Member since 2020 · 3 posts · 1 vote
    5y

    Everyone, Thanks for the replies. I've been out of touch over Christmas. First, I am NOT holding the properties in the scorp. These are all personally owned (mortgaged). The duplex that is our primary residence is mortgaged as a primary residence and we live in one apartment. Basically, everything has been run personally and I want to run it as a business. 

    For 2020,  sort out payroll & distributions before year end to maximize tax benefits and minimize taxes. Since the mortgages are held and paid personally, I would deduct things like mortgage interest and property taxes personally and through the scorp add the rental income, deduct capital, rental and utility expenses, salary, and distributions, correct?

    Thanks.

    0Reply
  • Linda WeygantPro Member
    Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
    5y
    Originally posted by @Mike Beall:

    For 2020,  sort out payroll & distributions before year end to maximize tax benefits and minimize taxes. Since the mortgages are held and paid personally, I would deduct things like mortgage interest and property taxes personally and through the scorp add the rental income, deduct capital, rental and utility expenses, salary, and distributions, correct?

    Thanks.

    Why are you doing this - what are you trying to achieve?  The S-Corp is not needed in order to be able to deduct utilities, etc.

    Also - capital expenditures are generally depreciated, not deducted.  Distributions are never deducted.

    Essentially what you are doing is adding 15.3% of SE taxes onto whatever you're declaring as salary.  Why?  Is this for lending purposes?  Mortgage brokers will see right through this.

    Also, you've got issues associated with arms' length transactions.

    There is so much here that just makes me cringe.  And I will repeat what I said before.  You are in the process of completely and totally hosing yourself and you need to step back for a minute, get with a competent professional and lay out what you're trying to achieve and come up with a different strategy that doesn't hose you so badly. 

    Podcast Guest on Show #244
    1Reply
  • Mike Beall
    OP
    Member since 2020 · 3 posts · 1 vote
    5y

    @Linda, this is why I am asking questions. I haven't done anything with the scorp and can just file everything personally, if that is what you are saying. Yes, I understand capital expenses are depreciated, I was speaking loosely. Sorry to muddy the waters.

    1Reply
  • Roshael Reece
    Member since 2018 · 11 posts · 2 votes
    5y

    @Linda Weygant What are some of the niche circumstances that you should hold properties in an S-Corp? Thanks!

    0Reply
  • J.C. Martel
    Investor · Lawrence, KS · Member since 2012 · 50 posts · 15 votes
    4y

    @Roshael Reece, I have the same question. I have an S corp holding two properties and thinking of going back to the more common LLC structure for any future properties that I buy. I realize that I can move my properties from S corp to LLC within triggering a sale in the eyes of the IRS. Not sure if I should just keep moving forward as an S corp for this reason.

    0Reply
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