Boomer’s Blog

What would July be without fireworks, outdoor cooking, and patriotic reflection that inevitably collides with the fiscal year’s fourth quarter, and for many real estate entrepreneurs, another giant tax headache.

Although a career in real estate investing affords us with many freedoms, for many of us, it does little to simplify our taxes. But selecting the best tax entity for your business can definitely take some of the sting out of meeting Uncle Sam’s ante.

Real estate investor, accountant and attorney John Hyre writes “Choice of Entity 101,” a great article to help members of our community choose the tax structure that’s best suited for our individual businesses based on the scale of operation, income source and type, and other details. Although he advises that we all should seek qualified guidance with our taxes, here are a few of his simple guidelines to point us in the right direction:

• Limited Liability Companies (LLCs) often are the best option for holding rentals and most lease-optioned properties because they’re usually inexpensive to set up, afford investors maximum flexibility and offer great tax perks, such as: good tax rates on capital gains, depreciation deduction generation (especially useful in many of today’s markets), potential for tax-free real property exchange, opportunity to generate low-income housing credits and more.
• S-Corporations are commonly the best structure for flip properties, however. They’re “pass-through” entities that generally are easier and less expensive to operate than C-Corporations. Although they’re less flexible than LLCs, a great advantage with this structure is that dividends are exempt from social security taxation if the owners are paid a reasonable salary. This is significant because flip income might otherwise be subject to a whopping 15 percent social security tax.
• High-income earners with self-provided benefits may see the greatest advantages by using a C-Corporation. Here, taxes are paid based on income brackets. Though a C-corporation’s first $50,000 in income may be taxed at 15 percent, folks in the brackets above 35 percent are likely to see the greatest advantages to using this structure. But, Hyre says, administration costs can quickly consume the benefits. Usually, this option is best for secondary businesses because it gives real estate investors the option to pay the C-corporation enough to fund benefits, but not so much that the prospect of double taxation becomes another costly tax challenge.
• Incorporate in your home state: think twice and do your research before listening to anyone who tells you that you’ll save money by incorporating in Nevada, Hyre suggests. Chances are good that because you’re still doing business in your state, your business remains subject to those laws. Incorporating in other states, such as Nevada he cautions, is likely to cost more than it’ll save you in the long run.