LLC Taxation

I’ve formed an LLC partnership (2 person) whose sole purpose is to invest in real estate. I’ve been asked how I want the structure to be for tax purposes…ie partnership, s-corp, corp. I know that once you make an election for s-corp or corp, that you must maintain that election for 5 Years. Having all the income pass through will result in a lot of taxes for me. My partner is completely passive, so they will not have to pay self-employment taxes on their share. Any recommendation and pros/cons on choosing a taxation classification?

“it depends.”

what type of real estate activities are you going to pursue?

I plan on doing a rehab and flip to begin with but then work into some buy and hold. Are there any disadvantages to being taxed as an s-corp? Also, I just began my business last year and was looking into changing the classification to S-corp for 2012 (Deadline is tomorrow), but was told by the IRS that I would have had to file as an S-corp for 2011, that once you file a tax return, that is your classification and the only way to change that is to dissove the business and start a new one with a new EIN. Great. Why do they even have Form 2553 where you can elect to change your current classification??? Please let me know if the information I received is correct.

Last things first:

You can file your S-election with your 2011 return. Yeah yeah yeah the deadline was months ago, but you can petition for relief for the late filing no problem. I’ve never seen a late election denied when done correctly. The exact procedure depends on if you already filed the 8832 to tax the LLC as a C-corp, or if you need to go straight from partnership (default) to S-corp.

If you’re going to go S, you want to do that from the beginning. You want to avoid having income… and more importantly losses… tied up in the C-corp before it becomes an S-corp. Otherwise you will NEVER benefit from those C-corp losses. They get tied up and cannot be used by the S-corp.

If you’ve already filed (did you have activity in 2011?), you have six months from 3/15/12 to amend, claim relief and take the S-election for 2011.

Dissolve the business? Pul-eeze. :bs

Never hold rental property in a C-corp. You cannot benefit from losses in a C-corp; you can’t get cash out of a C-corp without triggering double taxation; the list goes on.

Never hold rental property in an S-corp. It can create basis problems if you finance with non-recourse debt. In addition, distributions from an S have to be at market value, which could trigger a taxable event if you ever withdraw an appreciated property. Partnerships and LLC’s treated as partnerships don’t have these issues.

Hold rentals in partnerships and LLC’s taxed as partnerships.

Flipping is business income, and as such is subject to income plus self employment taxes for ~35%-45% total tax bite. Ouch. If you run flips through an S-corp, AND have enough cashflow to pay a salary (complete with W-2’s, 941 payments and the whole deal) then you may be able to save some self employment tax. This only works if you have enough cashflow to pay a reasonable salary AND want to deal with the hassle of running a payroll. However, S-corp is the ONLY entity structure that will provide this benefit.

So flip in an S-Corp.

Neither S-corp or partnership (or LLC taxed as either one) will change your income tax one cent. Business expenses are always deductible. Flips are always business income and not capital gain. Capital gains are always taxed on the 1040, etc.

These are general rules, and you specific facts and circumstances may indicate a different answer would be appropriate for you. Your mileage may vary.

There was something else I wanted to say, but I forgot. Maybe I’ll remember later.

Good luck.