When you have just one rental property in Orlando, it may seem most natural to claim the additional income as a sole proprietor on your taxes. However, as business expenses increase, and you invest in subsequent properties, you may want to consider forming a business entity rather than merely filing a single tax return.
Forming an entity like a C Corp, S Corp, or Limited Liability Company (LLC) will cost you a few hundred dollars—but they provide a variety of benefits along the way as you make your path to long-term real estate investment success. They also help you see yourself as a business owner and entrepreneur—not just as someone who is doing some real estate "on the side."
A note: This blog post is not intended as legal guidance, merely an exploration of your potential business entity options. When in doubt, consult your legal counsel.
Why Establish a Real Estate Business Entity?
The biggest reasons to establish a real estate business entity are to accurately and legally complete your taxes in the United States and to protect yourself in the case of a liability lawsuit.
While it takes a little bit of time and money to register your business as an official Limited Liability Corporation, C Corporation, or S Corporation, you will reap the benefits, either through the protection you'll receive or through accurate and precise taxes. Your accountant will thank you if you form the correct real estate business entity for your situation, and either your personal attorney or online legal service can help you determine which specific entity will work best.
Different states have slightly different tax rates and requirements for those who are working with particular entities, and some of the benefits of, say, an S Corp, don't kick in unless you have substantial income from your business. Focus on getting at least an LLC—which tends to be a useful entity for a lot of different circumstances—and asking your accountant or attorney if another form of a corporation might better suit your needs.
The Benefits of Keeping Business and Personal Finances Separate
While people sometimes choose to separate business income and personal finances even before they want a business entity, having a separate entity can help you see the benefits.
If you keep your business income in a different account, you can make all your choices about the business income before you pay yourself. If, for instance, you need to make mortgage payments on a rental property, or you need to pay your estimated taxes on your rental income, paying it from your business account is an excellent way to keep all that business expense accounted for. Then, when you pay yourself out of your business income, you know that you are free to use those "wages" as you see fit.
This separation becomes even more useful when you hit tax time and want to ensure that you only claim the expenses that were directly connected to your business. While the goal is not to receive a tax audit, those who keep their personal and business costs separate have a much easier time in the case of a tax audit as they prove that every deduction was taken correctly and that they paid the right amount.
Why a Business Entity Might Protect You in a Bad Situation
While most landlords will not experience this issue, some landlords may encounter a situation where they are involved in a lawsuit from a tenant. If a tenant feels they have grounds to sue you, it can be incredibly frightening to think that one's entire livelihood and assets are at risk.
However, when you have a Limited Liability Corporation, the assets that can be accessed by the lawsuit are only those held by your business—not money held by you as a private citizen. These entities allow you to avoid going bankrupt in a disappointing or disastrous lawsuit because you made an effort to keep personal and business expenses separate.
Consider the Benefits with Your Attorney or Accountant
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