Can I Use an S Corporation For Real Estate Investing?

Okay, sure, you can use an S corporation for real estate investing.

But most of the time, you shouldn't. 

Let me explain why. But before I do that, remember that I love S corporations. If there was anybody who would be tempted to try and find a way to make the S corporation option work for real estate investors, that anybody would be me.

Is Real Estate Really Your Business?

Here's the first thing to know about the idea of using an S corporation for real estate investing...

Typically, investing in real estate doesn't rise to the level of an active trade or business. And that's really significant.

Because real estate investing isn't considered an active trade or business, profits from real estate investing are subject only to income tax and, possibly, net investment income tax.

But the profits are not subject to self employment tax.

The "no self-employment tax" angle is important. Because real estate investors typically would not pay any self-employment tax anyway, real estate investors who use an S corporation don't get any extra self-employment tax savings from an S corporation.

The only thing the real estate investor does by using an S corporation is complicate his or her tax accounting.

And another thing to know about this: An S corporation can also allow you to sidestep the net investment income tax (also known as the Obamacare tax). Which sounds interesting. But if you're a real estate professional, you don't need the S corporation to accomplish this avoidance. You get to avoid the net investment income tax on real estate profits anyway.

Note: I've got a blog post here, Real Estate Investors and the Net Investment Income, that talks about this net investment income tax stuff. But you can also for purposes of this discussion simply remember that an S corporation doesn't save you net investment income taxes if you're investing in real estate.

But wait, it gets worse...

Thou Shall Not Put Real Estate Inside a Corporation

Another reason to avoid using an S corporation for real estate investing concerns the problem of later on getting the real estate out of the S corporation. This conundrum shows up in a couple of places.

First, while you can put real estate into a corporation you own without tax consequences as long as you follow the rules of Sec. 351, you can't typically remove real estate from an S corporation without tax consequence. Rather, the distribution of property like real estate from an S corporation means any appreciation of the real estate gets taxed when you remove it.

As a practical matter, what this means is that you will need to keep your S corporation in existence for at least as long as own the real estate.

Note: If you put real estate into a partnership or an LLC treated as a partnership, in comparison, you can pull the real estate out of the partnership without tax consequences. Or at least you can with a little bit of help from a tax accountant.

Anyway, that's one problem with simply having real estate inside a corporation or an S corporation.

And then there's a related problem connected to your possible future estate planning. You might not think so right now if you're just getting started in real estate and plan to own your properties for years and years. But you may eventually want to transfer ownership of your real estate to some other family member.

For example, perhaps after decades of successful real estate investing, you may decide that you want to begin to gift property or percentage interests in your property to your children or grandchildren.

Unfortunately, you will not be able to gift real estate from the S corporation to a child or grandchild without paying tax at the time of the asset is removed from the S corporation (for the reason described a few paragraphs ago).

Further, while you maybe can gift interests in the S corporation, because of the restrictions on who can own shares in an S corporation and the rigid rules for allocation profits and making distributions, you really won't want to be doing this sort of gifting with an S corporation. Too impractical and complicated...

In comparison, if you own real estate individually or you own real estate through a limited liability company treated as a partnership, you will be able to gift the property without paying any income tax.

Flippers and Property Managers May Want S Corporation

Two final, quick exceptions to the general advice provided in the earlier paragraphs.

Here's the first exception:  Some real estate investors aren't really investors-at least according to tax laws. Some real estate investors are really property developers who renovate and rehab.

In this case, the profits that stem from the investor's real estate activities probably are subject to both income tax and self employment taxes. And, in this special case, the real estate investor may benefit by using an S corporation, just as with any other active trade or business does.

So that's something to consider.

Here's a second exception: Some real estate investors like to set up separate property management company that just "manages" the real estate. In these cases, you might want to operate the property management company as an S corporation. You probably would not be doing this, by the way, to save on payroll taxes. Rather, you'd be doing it to provide fringe benefits to the owners... stuff like pension plans and health insurance.

And note something important: With a property management S corporation, you would not have the S corporation own the real estate. You would own the real estate directly or through something like a limited liability company.

Note that in both of these "exceptions," however, you're not really using the S corporation to hold real estate for the long run. You're using the S corporation for an active trade or business.

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Additional Information You May Find Useful

If you want additional information about how to maximize the tax savings related to running a business or investment venture, you may also be interested in one of our downloadable e-books (see descriptions below). Each book covers a category of tax planning topics that easily save a business owner significant amounts of income or self-employment taxes (potentially thousands of dollars a year) and is instantly downloadable.

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