Choosing the Right Business Structure for Your Long-Term Rental Property

Setting up the right business structure for your long-term rental property is essential for long-term financial health and tax efficiency. Many business owners, especially those in real estate, find themselves with the advice from their accountants to set up an S-Corp instead of an LLC. However, this decision can be complex and requires a thorough understanding of the benefits and drawbacks of both structures.

Why Your Accountant Might Recommend an S-Corp Over an LLC

My accountant suggested setting up an S-Corp many years ago, and I followed his advice. However, after discovering that New York does not recognize S corporations, I had to adjust my strategy by switching to an LLC. By doing so, I have been saving about $9,000 annually in NYS taxes. Here's why an S-Corp might be recommended:

Tax Efficiency and Protection

Tax Savings: From a tax perspective, an S-Corp can offer potential savings. Some profits of an S-Corp entity can be paid out as dividends, which are not subject to self-employment tax. In contrast, in an LLC with the default tax status of a partnership or sole proprietorship, all profits are subject to self-employment tax. However, an LLC can also be taxed as an S-Corp if needed.

Ease of Maintenance

Lower Maintenance Costs: Maintaining an LLC is generally easier and less expensive than maintaining a corporation, whether S or C. For instance, in California, LLCs can face increasingly higher fees based on gross receipts, while corporations have a flat fee of $800 per year, regardless of income. Here's a breakdown of the fees for an LLC in California:

No LLC fee if the income is $250,000 or less $1,700 with an LLC fee of $900 and LLC tax of $800 if the income is between $250,000 and $499,999 $3,300 with an LLC fee of $2,500 and LLC tax of $800 if the income falls between $500,000 and $999,999 $6,800 with an LLC fee of $6,000 and LLC tax of $800 if the income is between $1,000,000 and $4,999,999 $12,590 with an LLC fee of $11,790 and LLC tax of $800 for income greater than $5,000,000 in a single fiscal year

In low-margin businesses, you can have significant gross fees but modest net income, and the same high fees apply. It's crucial to consider these costs when evaluating the overall tax benefits.

Protection and Flexibility

Legal Protection: Both S-Corps and LLCs offer liability protection to their owners. An LLC provides some of the same protections as an S-Corp, making it a suitable alternative. However, the specific requirements and paperwork for maintaining an S-Corp can be more complex and burdensome.

Conclusion and Advice

The decision to set up an S-Corp or an LLC ultimately depends on your specific circumstances, including your state's laws, the nature of your business, and your personal financial situation. An accountant's recommendation to set up an S-Corp can be well-founded if the tax savings and legal benefits outweigh the additional compliance costs. However, it's essential to carefully evaluate these factors and consider alternative structures that might offer a better balance of benefits and costs.

Key Takeaways:

Review your state's laws regarding S-Corps to ensure compliance. Evaluate the potential tax savings and compliance costs for each structure. Consider the legal protection offered by both structures.

For detailed advice, it is always best to consult with a professional accountant or tax advisor who can provide tailored guidance based on your unique circumstances.