When it comes to real estate investing, two of the most popular business entity options are S corporations (S corps) and limited liability companies (LLCs). Both offer liability protection and pass-through taxation, but they have some key differences that investors should consider. This article will compare S corps and LLCs for real estate investing, analyzing the pros and cons of each structure. Factors like flexibility, ownership restrictions, tax implications, and costs will be examined to help investors decide which is better suited for their goals.
LLCs offer more flexibility in structuring ownership and profit allocations among members
One major advantage LLCs have over S corps is flexibility. LLC operating agreements can divide profits and losses in virtually any manner agreed to by the members. For example, one member could be allocated 90% of profits while only holding a 50% ownership stake. S corps lack this flexibility – shareholders must receive distributions proportional to their ownership percentage.
S corps have ownership restrictions that do not apply to LLCs
S corps cannot have more than 100 shareholders, and all shareholders must be US citizens or resident aliens. LLCs face no such restrictions, allowing for more diverse membership. In addition, other entities like trusts and corporations can own LLC membership interests but not S corp shares. Thus LLCs provide more options for structuring ownership.
LLCs avoid double taxation for non-active members
S corps require all shareholders receiving distributions to pay Medicare and FICA taxes on their share of income. But with LLCs, “passive” members who are not actively participating in the business can avoid paying these taxes. For a real estate investor who takes more of a passive role, forming an LLC can result in significant tax savings.
S corps may have tax advantages for active real estate investors
Unlike LLC members, S corp shareholders who substantially participate in the business do not have to pay self-employment taxes on the full share of allocated income. Instead, they only pay these taxes on “reasonable compensation” which is typically defined as the value of services rendered. For active real estate investors, this presents an opportunity for considerable tax savings.
In summary, LLCs provide more flexibility in structuring ownership and allow certain members to avoid double taxation, while S corps offer tax reduction opportunities for active shareholders. Investors should weigh these and other factors carefully based on their specific situation to determine the ideal real estate investment entity.