Do you want to protect your rental property? What business entity should you chose? How does the taxation work?

So these few questions I get quite often when a couple decides to move into a new house or few investors want to buy rental properties. They want to know what should be done with the rental property.

To put it simply, I generally recommend putting the rental property into a LLC (Limited Liability Company). Now, I’m not a lawyer and not going to discuss how much liability you will get or not get, but generally, having a Limited Liability Company will give you some protection from personally being liable in legal cases. Typically, when you form an LLC, the assets that are in the business entity tends to be at risk versus the partner themselves being fully at risk if no LLC was formed.

So, let’s talk about other entities versus LLC from a tax point of view:

C-Corporation: The biggest issue regarding putting the rental property into a C-Corp is due to double taxation. Let’s say the rental property generates $10,000 for the year, so 15% would be subject to Corporate Income Tax. $1,500 (10,000 * 15%). Now, if you want to withdraw the rental income from C-Corporation, the withdrawal would be considered a dividend distribution, which would require a 1099-DIV form to be filed and the distribution would be taxed on the 1040 as well. Hence the term “Double Taxation”, once at the corporate level and the other at Personal level.
S-Corporation: Generally, Rental income can be considered a Passive Rental income, so which can cause some issues here if you form an S Corporation due to the fact, that if more than 25% of the corporation gross receipts come from passive investment income for 3 consecutive years and corporation had C corporation accumulated earning and profits at the end of the year. The S corporation status would be terminated.

Limited Partnership: Now with a limited partnership, you need at least one general partner and one Limited partner. The issue is here the general partner would be subject to personal liability and if the limited partner takes on responsibilities of a general partner, then technically you not operating as a limited partnership anymore, which can cause the limited partner to be incur personal liability.

LLCs: As mentioned earlier, with an LLC, not only do you get liability protection but you operating as a LLC has its tax advantages as well. For one, there is no “Double Taxation”, all income/deductions are pass thru to your Schedule E on your 1040. Second, if you have partners in your LLC, based on your operating agreement, you can apportion profit/loss the way you like between each partner. Third, you can generally avoid many of the hassles of having a S or C corporation, such as boards of directors, board and stockholder meetings, and elaborate corporate recordkeeping

The taxation of a rental property as follow:
– Complete 1065, if there are two or more partner – include rental income/loss on IRS Form 8825.
– K-1 will get issues to each partner. Then the rental income will get picked up on partner’s schedule E on 1040.

Modi CPA is a licensed firm in the state of Texas in The Colony, TX. We are a qualified firm to discuss Domestic tax matter involving rental of real estate and Offshore/Foreign US tax implications regarding Inbound and outbound matters. Do not hesitate to contact our office should you have further questions. Our Phone number is (904)616-5918 and email is RaviModiCPA@gmail.com