I’m new to real estate investing, so new in fact that I haven’t made a purchase yet. I’m doing as much research as I can to try to prepare myself for the road ahead.
On the topic of incorporating I’m still rather confused. Primary in the beginning I’m looking for flip some properties. While I would like the asset protection, I think the main concern is taxes.
I see that S corporations seem to be common for this, but what I don’t understand really is why I would want the profits to flow through to my individual return. Won’t I be taxed at a higher rate in this case?
I also don’t want to over complicate the matters while just starting out, but at the same time I don’t want take a big chunk out of profits because I failed to form a corporation.
Any help is appreciated. I know i will want to consult a tax advisor, but I’d like to at least get a better understanding of what I want before I blindly follow the advice of someone else.
Just a little that I know which may help. S Corp from what I understand all the taxes flow thru to your personal return. You do have the advantage of taking several deductions that you would not be allowed as just a person buying and flipping and the main part of this is just perks like insurance that you probably would not buy yet any way so there would be no tax benefit to a S corp.
Most advice I have read is to use a C corp to flip. You can pay yourself a salary and pay corp tax on the remaining profit and keep the funds as retained earnings and not pay out dividends to the stock holders. You can also have the same perks and asset protection to some extent. Most lenders will still have you sign personally on the loans you get no matter what form of ownership you choose.
Look up my article on entities on this website - it provides some guidelines. In a nutshell:
S-corp has one use and one use only: To reduce social security/self-employment taxes. Not an issue with rentals. It’s often an issue with flips, especially if you make < $90,000 via other sources. S-corps have no other significant tax advantages when compared to an unincorporated business. A limited partnership also has the ability to reduce social security taxes, though they tend to be a bit harder to run than an S-Corporation. The state you live in may affect this analysis. For example, TX taxes LP’s more favorably than S-corps.
C-corporations are useful in three situations:
- They are taxed at 15% on the first $50,000 of taxable income - this is useful if you are personally in a 30% bracket, for example.
- C-Corp pensions can be stuffed with lots of money if you are using a “defined benefit” plan, are in your 50’s and want to put lot’s away for retirement tax-free every year. Doctors, for example, have used this sort of plan to contribte $100,000+ per year tax free.
- You have large medical expenses not covered by insurance - such expenses can be deducted through a “medical reimbursement plan” in a C-Corporation.
While C-Corporations have a few other unique benefits, these benefits are fairly minor. They may be worth taking if you already have a C-corp, but do not alone or even in tandem make setting one up worthwhile.
If I understand this correctly:
If i’m already getting > $90,000 income then i’m already being taxed the maximum for social security and medicare, so a S Corporation isn’t really doing anything for me.
Because I’m at a higher tax bracket, then leaving some of the profits in a C Corporation to be reinvested into more property could give me a bit of a tax break as the corporate rate is lower up to about $50,000 or so.
So if my goals were to seperate my personal assets from my investments assets AND I wanted the ability to make deductions from these business endevours AND I wanted to be able to leave a little money in the company to reinvest, a C Corporation is looking to be my answer?
I’m in the same boat as you. new and motivated to get staerted.
Doesn’t a LLC have most of the same benefits other corps do with less paperwork, fees, etc???
I do not know enough about you to agree or disagree…sounds right overall, but there are lots of details that go into the decision. C-corporations are highly overrated - most deductions are available to a BUSINESS, regardless of whether it’s an entity, much less a C-corporation. There are a very few deductions that are both helpful and exclusive to C-corporations.
For me it seemed like the passthrough taxation of a typical LLC might be great for some people. I like in the SF Bay Area so real estate prices are pretty high, and I would be dealing in larger amounts of money then people in other markets.
If profits from any of these transactions were to pass through to my personal tax return I would get hit real hard with taxes due to the combined income of myself and my wife. This is money that could easily be but back into the business at a lower corporate tax rate and used for other purposes. This “income splitting” seems to be something that would be make corporations beneficial.
The other option that interested me was doing an LLC but taxed as a corporation. My initial understanding is that this could give me the simple flexable benefits of the LLC, but still allow for “income splitting”. I’m not sure if anybody has any experience with that idea.
It does not take very much taxable income, for the C-Corp tax rate to exceed the rate charged on your personal income tax return – for income that exceeds $75K the corporate tax rate is 35%.
All net income earned by the C-Corp is taxed once on the corporate return at the corporate rate, then again on your personal return for any dividends you take from the corporation.
Very true. I was hoping with proper planning, I could keep the corporate income in a tax bracket lower than myself. As for the dividends, I had understood that the double taxation is exactly why most corporations don’t pay dividends.
Do you have any recommendations overall? I’ve been doing so much research that my head is swirling with all the options.