Investment Real Estate Ownership Options
We often are asked if investment real estate should be acquired personally, through a limited liability company (LLC), partnership or corporation. Our answer always depends on the facts and circumstances of the situation. Below we have detailed some of the pros and cons related to owning investment real estate personally or through a business entity. However, in order to answer the question we must define and insure we are dealing with what is truly considered investment real estate.
Investment real estate is real estate acquired with the intention of holding for long term appreciation in value and/or rental real estate. Real estate acquired for the purpose of resale or development is not considered investment real estate.
Because LLCs and partnerships are treated the same for income tax purposes, we will generically refer to LLCs below. LLCs and corporations can provide limited liability protection. However, in order to maintain the liability shield, certain formalities need to be followed, such as a separate checking account and annual minutes. Also certain states have specific requirements. In North Carolina an annual report and fee is required.
Owning Property Personally: Having property in your personal name is usually the easiest to account for and manage. The title can be in a single individual’s name or in multiple names. Expenses related to the property can be paid from a personal checking account and a separate income tax return is not required, as with other forms of ownership. It is often easier to obtain financing and usually the interest rates on personally owned property are less than those rates charged to a business entity. However, owning property personally may not give you any liability protection in the event of a lawsuit or tragedy. Further, title to the property is in your personal name versus that of an entity, thereby eliminating the anonymity to some extent. If ownership changes for any reason, the deed to the property must be changed.
Owning Property in a Single Member LLC: If the LLC has a single owner, the entity is disregarded for income tax purposes and there is not a separate tax return filing requirement. The property would be deeded to the LLC directly. All related income and expenses would be reported directly on the owner’s income tax return. The benefit of a single member LLC is it may provide limited liability protection for the owner. Although the LLC is disregarded for tax purposes, the LLC needs to function like a separate entity as discussed above. The annual fee for an LLC in North Carolina is $200.
Owning Property in a Multi-Member LLC (or Partnership): Property may be transferred to or taken out of an LLC, typically, without any immediate tax consequences. Unlike an S corporation, partnerships, corporations, and other LLCs can be owners in an LLC. LLCs may provide limited liability protection but the basic formalities must be met to help ensure the liability shield is not pierced. An LLC with more than one owner is required to file a separate income tax return. The net income or loss related to the entity is allocated to the owners to report on their personal returns. Since the property is deeded to the entity, additional investors can be admitted to the entity or ownership of the entity can change, thereby changing the ownership of the property without actually having to change the property’s deed. Keep in mind that changing your ownership in the entity may result in a taxable transaction. LLCs allow for flexibility in profit and loss allocations, distributions and ownership changes but the benefit of the flexibility means the structure can be very complex and difficult to account for and understand.
Owning Property in a Corporation: If property is owned in a corporation, the corporation is required to file an annual income tax return. If the property is taken out of the corporation and deeded to the shareholder(s), it is deemed the shareholder purchased the property at fair market value, even if no money changed hands. If the property has appreciated in value, the gain realized is taxable immediately. If there is a loss, the loss is not recognizable due to the related party loss rules.
S corporations, like LLCs, do not pay any taxes at the entity level, thus any gain or loss resulting when property is sold is taxed on the individual owner’s return based on their personal tax bracket and the character of the gain (ordinary income vs. capital gain/loss). C corporations pay taxes directly on the profits of the company and do not get to realize the favorable capital gains rates because all income is considered ordinary income. Also, profits in a C corporation are subject to double taxation.
In North Carolina, all entities filing a corporate tax return are required to pay a franchise tax. This tax can be on the higher of the appraised property tax value of the real estate or the original cost. Franchise taxes are not assessed when filing an individual or LLC tax return.
If you are considering purchasing real estate and are trying to determine the entity and related tax consequences or benefits, please contact our office and we will be glad to discuss this with you.