Investing in real estate is a business transaction. Whether you will rent your property to tenants or repair it and sell it for a profit, there are financial and legal considerations. When you buy an investment property, it may not be in your or your family's best interest to hold the title in your name. Choosing the right business structure for your asset is as important as choosing the right property to buy.
According to the Internal Revenue Service, an S corporation acts as a pass-through entity for tax purposes. This means that income and losses are passed to a company's shareholders, who pay income tax based on their personal tax rate and not as businesses. Therefore, the corporate entity does not pay taxes on its gains. An S corp also provides protection to owners from personal liability. If your business is sued or you cannot pay back a debt, your personal assets cannot be attached in a court judgment or sought for payment by creditors.
You are allowed to form an S corp for your business if you have shareholders, but it is limited to 100 individuals, trusts or estates. An entity, such as another corporation, cannot be designated as a shareholder and you may have one type of stock only. The profits and losses of the business must be split according to the amount of ownership in the company. To become an S corp, you first file articles of incorporation for a standard corporation with your state's Secretary of State office. Then each shareholder must Form 2553 with the IRS to be given the "S" designation.
S Corp vs. LLC
A limited liability company (LLC) is another type of business entity. An LLC also protects its owners, or members, from liability in a way similar to that of an S corp. However, the IRS does not require LLCs to have stocks or shareholders. An LLC may be owned by other business entities and may have an unlimited amount of members. Although pass-through taxation is a characteristic that both entities share, profits and losses may be split in any way among the owners of an LLC.
Real Estate Investments
An S corporation is not an ideal business structure for real estate ownership. Most real estate investors do not manage their investments as they would another type of business that sells goods or services. If you are buying real estate by yourself or with another person, you will not need shareholders in your business. However, if you file an S corp, you will be required to have stockholder meetings and document minutes. Liability protection is attractive to real estate investors and an important aspect of forming an S corp. However, using an LLC structure affords you the same shield from liability and each property can be held in an LLC so that other investments may not be attached if you are accused of negligence or owe business debts.