Organizational Structuring

One of the first and most important decisions when investing in real estate involves how you structure the activity. There are many forms of organization to choose from, with each having its own set of costs, benefits, and tax consequences. Identifying the alignment bewteen the organizational and operational sides of your real estate activity can have meaningful implications for the tax treatment of the activity.

Limited Liability Company

The Limited Liability Company (LLC) is the most common form of organization for most real estate investors who intend to hold their investments. When you buy and hold real estate, it is considered a capital asset. The primary goal for investors who buy and hold is to achieve rental income and long term capital appreciation. In most states, the ownership of real estate does not constitute the transaction of business. For that reason, a Delaware LLC formed for the sole purpose of owning real estate is not required to register as a foreign LLC in the state where the real estate is located.

S Corporation

Some real estate investors engage in a business practice commonly referred to as "flipping" real estate. This means the investors buy and sell real estate with the goal of generating a quick profit. When real estate is flipped it is considered inventory and the investor is considered a dealer. A real estate dealer cannot take advantage of the following tax benefits that are available to buy and hold real estate investors:

• Capital gains tax rate
• Depreciation deductions
• Installment sales method for recognizing gains
• Tax free like-kind exchanges under I.R.C. Section 1031

Real estate investors who flip real estate may benefit from forming an S corporation (or LLC taxable as an S corporation). This allows the dealer to avoid self-employment tax on a portion of the profit earned from flipping real estate.

Limited Partnership

While there may be some estate planning benefits to forming a limited partnership, the same benefits can be accomplished by forming a limited liability company that issues nonvoting units with restrictions that are equivalent to those on limited partners in a limited partnership. In most cases, it is better to form a limited liability company instead of a limited partnership since the filing fee to form a limited liability company is typically less than the filing fee to form a limited partnership. If you decide to form a limited partnership, it's important that you form a separate entity to serve as the general partner to avoid personal liability for individuals who manage the limited partnership.

C Corporation

Some real estate investors form corporations. While a corporation provides the greatest protections to the owners, they are also the most expensive and cumbersome to form and maintain. They are also generally taxed on their own, meaning the entity bears the responsibility for paying its own taxes rather than passing the income thrrough to the owners for recognition on their individual returns.

Conclusion

Investing in real estate offers several unique benefits from a tax perspective. Determining how best to structure your real estate activity is key to unlocking these benefits. Tax Muscle can help you identify and set up the most beneficial organizational structure for your real estate business based on your investment strategy, helping you achieve its full tax savings potential.