Should you form an LLC or S-Corp for your real estate or construction company?

Does this question bother you way longer than what it takes for concrete to dry?

It shouldn’t, when your attention should be on what you do best – counting rental yields or constructing the next skyscraper.

In this blog, we deconstruct the most important factors to consider in whether an LLC or S-Corp is a better fit for your real estate business.

Let’s get cracking!

Pros of an LLC for real estate

Personal liability protection

This is often at the top of mind when setting up a real estate investment or construction company as an LLC. There are several risks to consider when it comes to buying, operating and building a property. Owners could face foreclosures and third-party damages, not to mention the huge costs of managing inventory and workers for builders.

An LLC hence takes the sting out of the dangers to your personal assets from owning or building a property.

Multiple partners

Suppose you own a property but would like to bring other investors on board. The cost and time involved can be frustrating, seeking permission from your mortgage lender and making changes to the title deed.

Doing this through an LLC can make things much more straightforward. Often all it takes is to elect the LLC to be taxed as limited liability partnership (LLP), amend the LLC’s operating agreement or charter, and specifying distribution of ownership as well as profits and losses.

Literally slicing a property is also potentially easy with an LLC. Subdividing a parcel is usually considered an internal business activity, and you could reduce your tax burden from capital gains and other incomes. 

Cons of an LLC for real estate

Due on sale clause

Things could get tricky if you want to transfer an existing property to an LLC. Some lenders impose a due on sale clause which could interpret the transfer as a sale, potentially triggering full payment of your remaining mortgage.

It’s best to clarify with your lender beforehand that you are effectively still the property owner through the LLC and there’re no sales proceeds involved.

Additional expenses

An LLC avoids double taxation at the corporate and personal level if you have an active real estate activity (construction, property management, etc.). But 15.3% of self-employment taxes on top of personal income tax is not to be sniffed at either. Especially if you’re simply a buy-and-hold investor who’s not doing any meaningful work.

What’s more, a property transfer to an LLC may incur transfer fees or taxes, depending on the state you’re in.

Pros of an S-Corp for real estate

Lower self-employment taxes

If you operate a real estate business, like brokerage, construction or property management, electing S-Corp designation helps to minimize your tax liability. As an owner-operator, you get to designate yourself and other managing shareholders as employees of the business, and the 15.3% FICA rate applies only to the declared payroll but not to the full business income.

This gets even more feasible if you’re a group of builders who get taxed proportionally based on the actual work put in on the roof.

Short-term dealers

Short-term dealers who buy and sell, or flip, property within a year face a double whammy. They do not enjoy the capital gain tax rates for longer-term investors nor benefit from depreciation tax deductions. As a result, an eye-watering federal income tax rate of up to 43.4% awaits, alongside 15.3% of self-employment taxes in an LLC.

Oh, make that a triple blow instead, because some states may have income tax too. Yikes.

Forming an S-Corp hence makes this pill a little easier to swallow by doing away with the 15.3% for a portion of your “flipping” income.

Cons of an S-Corp for real estate

Subdivision of property

Because of the stricter regulatory oversight, subdividing a property under an S-Corp may not be as nifty as that in an LLC.

You may need to report the subdivided distribution, which could make the transfers taxable.

Administrative processes

Finally, an S-Corp comes with added administrative and regulatory requirements that may leave you pining for an LLC’s simplicity.

There’re stock issues, shareholder meetings, filing of such meeting minutes with your state and even creation of company bylaws.

Not to mention extra accounting fees from having to separate business income and expenses from personal payroll.

When should you become an S-Corp?

Generally, we recommend looking into an S-Corp once your annual revenue hits $100,000 or more for the tax savings to be worth it.

But as we can see from the above, there are a host of other factors influencing whether an S-Corp or LLC is better for your real estate or construction business.

Partnering a qualified, experienced business accountant like Basta & Company can help you save a ton of time and resources in working out which model to follow and when.

Simply book a complimentary 15-minute call with us here to see how we can start on this journey together. 

Until next time!