If you currently own one or more rental properties or are thinking about becoming a landlord, you should consider whether it makes sense to formalize your business structure using a corporation or Limited Liability Company (LLC). Whether you rent out a room in your home, have vacation property you lease out in the summer, or own a multi-unit apartment building, you might choose to incorporate for the potential tax advantages that come with doing so.
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Should I incorporate as a landlord?
Formalizing your rental business by creating a separate business entity for it may make sense for a variety of reasons. Whether you incorporate your rental business by creating a corporation or form an LLC under state laws, using a separate business structure and separating your business income from your personal income can protect you from being personally liable for the financial obligations or potential future legal troubles of the business.
Creating a corporation or LLC for your rental income also enables you to take advantage of business-related tax deductions, including everyday business expenses, property taxes and insurance on the rental property, expenses of maintenance and upkeep, property management costs, and even things like medical insurance premiums.
How is rental income taxed in an S-Corporation?
C-Corporations are taxed at the corporate level, and then again at the individual shareholder level. If you establish an S-Corporation, the profits and losses for earned income of the business are passed through to its shareholders – the entity itself does not pay taxes on earned income.
However, rental income is sometimes considered “passive income” by the IRS. This may be the case if the corporate shareholders were not actively involved in the property management. As such, the income may be taxed at corporate tax rates, rather than individual shareholders’ individual income tax rates. In addition, there is also a risk in certain circumstances that the amount of passive income for the corporation relative to its earned income could be too high for the entity to continue qualifying for S-corporation status under IRS rules.
How is rental income taxed in an LLC?
If you structure your rental property business as an LLC, the income is, by default, taxed as pass-through income to the LLC’s members. If you are the sole member in your LLC, you will report all of the income on your personal income tax returns and can deduct business expenses. There is not a separate income tax filing required at the business level, so you avoid the “double taxation” situation that can arise with corporate entities.
Are there tax considerations related to incorporating my rental property business?
If you choose a sole proprietorship model, you must report all of your rental revenues as income. This could put you in a higher tax bracket than you would face if you incorporated your business and paid yourself a salary instead.
Another potential consideration has to do with transferring real estate into an S-Corporation. If you transfer property that is subject to a mortgage into an S-Corporation, you could be subject to corporate taxation on the transfer under Internal Revenue Code Section 357.
As part of Congressional pandemic relief action taken in 2020, business owners – including landlords – may be eligible for additional tax benefits. The Rocket Lawyer Rental Income Tax Guide and COVID-19 Tax Relief for Rental Property Owners, both published prior to the passage of the second stimulus bill in 2020, outline possible tax deductions and credits for landlords.
Is incorporating right for your rental property business?
While there are potential business and tax advantages associated with incorporating or forming an LLC for your rental business, be aware that either approach comes with certain formalities and responsibilities that sole proprietors won’t encounter. You could also face unanticipated tax consequences when it comes time to sell rental property owned by a corporation.
If your primary objective in considering incorporation is to limit your liability rather than tax advantages, you may be able to obtain liability protection by creating a trust or purchasing landlord insurance instead.
The best approach for you will depend on your specific situation and goals. Consult with a Rocket Lawyer On Call® attorney for personalized advice and legal guidance based on your circumstances.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.