Disclaimer: This article is not a substitute for legal advice from a qualified licensed attorney and tax accountant. I am not an attorney, a tax accountant or even attempt to play one. The below article is strictly written for general education purposes and is based on my current understanding of the law. Before acting, it is highly encouraged that you seek out legal advice from a competent attorney and tax account for your specific situation.
Real estate investors often lose a significant share of their profits through taxes because they do not structure their business appropriately. It is not about just how much profit you make, but how much profit you keep. The tax man can giveth and taketh away if you don’t know what you are doing leaving you with very little. No disrespect to Uncle Sam, but why pay more than you legally need to. There are ways to legally reduce your tax burden by using the correct corporate structure or structures that provide the greatest tax advantages for the strategy or strategies you employ in your real estate investing. A key point to remember is that there is always a balancing act between asset protection and tax responsibilities. What may be the strongest asset protection strategy may not be the most advantageous tax wise, and vice-versa. Part of the art of real estate investing is balancing these two critical areas of your business in such a way that matches your risk tolerance and your specific situation. This is an area that I highly suggest you not go it alone. It is worth the money to pay competent professionals to help guide you to a corporate structure that meets your specific needs.
There are three common corporate structures, a limited liability company, a sub-chapter “S” corporation and a “C” corporation. There are advantages and disadvantages to each of these structures that vary with the strategy you are pursuing. It is beyond the scope of this article to get into all of the details. But in general, the net income derived from an LLC that is declared as a partnership, passes directly through the company to the tax returns of the limited partners of the company (i.e. no double taxation). Depending upon your current tax bracket, this could be good or bad. In an “S” corporation, the net profits are paid as dividends to the share holders of the company (again, no double taxation). In contrast, a “C” corporation is taxed at its own tax rate at the corporate level as well as at the dividend or salary level (i.e. double taxation). At first glance, this is not appealing, however, knowing that the first $50,000 of net profit in a “C” corporation is taxed at the 15% tax rate, this could be more advantageous; especially if you are doing a number of flips or assignments each year and you have a number of other long term rentals that you are holding in an LLC. The “C” corporation also allows other benefits such as the creation of retirement plans and health plans paid by the corporation that are not allowed to the same extent in an LLC. Knowing the strengths and weaknesses of each type of corporate structure allows you the ability to take advantage of the strengths of each type of entity. As for the beginning investor, however, it is usually advised to operate out of a limited liability company.
The critical point here is to match your corporate structure with your strategy. Plan ahead of time which strategy or strategies you plan to pursue, and create corporate entities that provide the greatest advantages from both an asset protection standpoint and a tax standpoint. It is possible, and advisable, to have more than one corporate entity if you are an investor who likes to have a varied portfolio of strategies. Choosing the correct corporate structure can help you take advantage of tax rates and save you thousands of dollars.
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