Here are the top ten reasons to incorporate your real estate business.
#1 Protection from personal liability
If you do business in your own name, you are risking everything you have. A corporation will separate your business from your personal assets. If you have a real estate deal that goes bad, a liability you can’t pay, or a lawsuit against your business, a corporation will be there to protect you.
#2 Less risk of an audit
If you are a broker, property manager, or anyone else who reports income on a “Schedule C,” you are a high risk for an IRS audit. The IRS audits Schedule C businesses much more often than small corporations. Simply by incorporating, you may reduce your risk of an audit by as much as 300%.
#3 It’s easier to sell the business
I have a friend whose realty company has his name all over it. In fact, without him, the business has no name. The point is, you can’t sell a business if the business primarily relies on you. You need to set up an entity that stands apart from you that can be sold as an ongoing business.
#4 Fringe benefits
You probably know that things like health insurance, medical costs, and life insurance are not fully deductible as an individual. However, if you set up a “C” corporation, you can deduct 100% of your medical insurance, medical expenses and up to $50,000 of term life insurance.
#5 Tax savings
A corporation can be an excellent device to turning nondeductible expenses into deductible expenses. For example, the old “home office” is a trap for small business people who try to claim the expense on their personal tax return.
However, if your corporation leased the same space from your home, you reduce the risk of being audited for the same deduction.
#6 Income splitting
If you operate as a sole proprietor, you are taxed on all profits you make, even if you reinvest the money into the business. A “C” corporation is a separate taxpayer from you.
The corporation pays its own tax, but usually at a lower rate than you pay (“C” corporation tax is only 15% up to $50,000). If you take a small salary and leave the rest of the profit in your corporation, you can effectively reduce your overall income tax.
#7 Prestige
Let’s face it, folks, a corporate entity just looks better. People will think you are more savvy if you are “North American Realty, Inc.” rather than “John Smith Realty.”
#8 Privacy
A corporation gives you privacy from prying eyes. It also gives you a buffer zone from your tenants. You don’t want your tenants to know you are the owner.
You are at a distinct negotiating disadvantage when you are the “greedy landlord.” Instead, you should represent that you are an employee of the management corporation. That way, you are just the “go between.”
#9 Portability
Real estate cannot get up and walk away. If a corporation owns your real estate, it can be moved easily, since the corporate stock can be transferred. If your real estate is owned in a corporation or other entity that has transferable ownership, the ownership goes where you go.
This is important in estate planning. If you own real estate in more than one state, your heirs must go through probate proceedings in each state. By converting the real estate into personal property (stock certificates), there will only be a need for probate in the state in which you die.
#10 IRS “dealer” status
If you buy and flip houses, you may be considered a “dealer” (rather than an “investor”) by the IRS. Dealers cannot defer paying income taxes on installment sales. Dealers must pay self-employment taxes on all gains. Dealers cannot depreciate property.
If you also have rental properties, the IRS can reclassify ALL of your properties as dealer properties and hit you with a big tax bill. If you use a corporation to buy and flip and another entity (such as a limited liability company) to hold your long term rental properties, you avoid the risk of this reclassification.
I hope these “top ten” reasons to incorporate your real estate business help you to decide whether a corporation should be part of your overall asset protection strategy.
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