Q: In a recent article, you discussed choosing an S Corporation versus a limited liability corporation (LLC) for holding real estate.

While I agree with much of your response, I have to bring up a difference in an LLC versus an S Corporation. The reader was referring to an S Corporation, which is not a taxable entity under most circumstances. Additionally, the S Corporation’s income “flows” to the taxpayer’s personal income tax return without incurring the dreaded “self-employment” taxes.

There are some tax consequences that the reader should discuss fully with his tax advisor and explore the pros and cons of his own tax situation.

A: Thanks for your comment. According to the IRS, “S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.” An S corp is a normal corporation but for tax purposes elects to be treated in a specific manner.

Let me also clarify another point: According to the tax experts I have spoken with, even if you use an S Corporation, if the income from the S Corporation is attributable to work performed by an individual, you would still be responsible for self-employment taxes.

That is to say, if an individual manages a property and part or all of the income from that property is attributable to the work put in by that individual, some of that income may be taxed as self-employment income even if the income flows through the corporation. You can’t set up an S Corporation solely to avoid paying self-employment taxes.

On the other hand, real estate investors using LLCs (limited liability companies) can get the benefits of having the taxes flow to the individual investors in the same manner as an S corporation but they also have additional advantages that would allow them to add more investors than in an S corporation; transfer the property to the individual investors at some future date without triggering the same tax consequences as with an S corporation; and an LLC also allows various owners of the LLC to own the property in different classes (that is to say, they can have voting and non-voting owners).

To read more, go to www.IRS.gov

If you are a real estate investor, could you leave us some of your observations in the comment section below as to whether you feel an S corporation or an LLC is better for investing in real estate?

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