If you’re considering forming a business for your real estate investments, it’s important you know which entity to choose. After all, an LLC has different benefits and restrictions from an S-Corporation—and choosing the right entity can help you save more money and grow more efficiently.
So how do you know which structure to choose? First, you should understand the differences between an LLC and an S-Corporation.
Next, you should analyze your business model to determine which entity is right for you. It might be both! Here’s what we recommend for real estate investors:
There are several reasons why a limited liability company (LLC) is the best entity for most real estate investors who buy and hold their properties.
First, it lets you report more of your business losses on your personal tax return, which saves you money. Make sure you are accurately tracking your expenses each month with professional real estate bookkeeping.
Second, it allows you to allocate profit and loss disproportionately among your partners.
In other words, if you and your partner each own 50% of the company but you do most of the work, you can pass more of the profit through to you as personal income. With S-Corporations, profits must flow to owners based on what percentage of the company they own—no more, no less.
Third, LLCs are typically cheaper to maintain than other entities. After all, the goal with buy-and-hold real estate is to wait for your assets to appreciate, collect rent, and if you’re lucky, see some decent cash flow. An LLC’s low maintenance helps you keep costs down while holding your real estate long term.
We specifically recommend forming a Delaware LLC. Why? A Delaware LLC is one of the most flexible legal entities in any state and offers some of the best legal protections. It also allows owners to file privately so that their names aren’t on public record.
An S-Corporation often attracts investors because of the employment tax savings. But this structure is ultimately best suited for rehabbing and flipping, which tend to cash flow quickly and yield bigger short-term profits.
The downside of an S-Corp is that you have to pay payroll taxes throughout the year. This creates a lot of paperwork. And if you’re not familiar with it, payroll can be very time-consuming, so it’s best to outsource this task if you can.
Filing taxes for an S-Corp is also more complicated. Your real estate CPA will most likely charge you more for it.
An S-Corp’s extra expenses and paperwork make it a riskier choice for investors. After all, payroll taxes are due each month, and overdue payments incur a late fee and interest.
This could be a big problem if you experience a cash-flow crunch that makes it hard to pay on time. So make sure your business is bringing in enough regular income to cover these expenses.
If you plan on using both strategies, then you should have at least one LLC taxable as an S-Corporation for your rehabs and flips and at least one Delaware LLC for long-term real estate.
Have you decided which entity is right for you? Leave your questions in the comments below!