3 Reasons NOT to Buy Rental Investment Property Under an S Corporation

Are you considering buying a rental investment property under an S Corporation? Think again! In this video, we break down 3 critical reasons why this may not be the best decision for your investment strategy. Whether you’re a seasoned real estate investor or just starting out, understanding the tax implications, legal risks, and financing challenges is essential to protecting your wealth and maximizing returns.

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What You’ll Learn: 

• Why S Corporations may lead to unnecessary tax complications.
• The risks of losing key real estate tax benefits.
• How financing and asset protection could be impacted by S Corporation ownership.

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DISCLAIMER:

This video is intended for education purposes and should not be taken as legal, financial or tax advice.  You should consult with a professional about your unique situation before acting on anything discussed in these videos.  Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. are providing educational content to help small business owners and individuals become more aware of certain issues and topics, but it cannot give blanket advice to a broad audience.  Things are always changing, therefore, this channel may not contain the most up-to-date information.  Neither Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. nor its members can be held liable for any use or misuse of this content.

TRANSCRIPTION:

The number one mistake that we see real estate investors do is putting or buying their rental properties under an S-corporation. This is a big no-no. In this video we’re going to tell you the top three reasons that you should not buy your rental property under an S-corporation.

Let’s go! Hello from Freedom Group. We are a group of four companies where we have been providing tax, accounting, immigration, real estate, financial planning, and insurance services for more than 20 years. So in this video we’re going to talk about the top three reasons that you should not buy your rental property under an S-corporation.

This is the number one mistake that we see real estate investors make. So reason number one that you should not buy real estate under an S-corporation is there’s no tax advantage. Why? Rental income is passive income.

S-corporations give tax advantages to businesses that generate active income. Why? Because when a business generates active income it pays federal tax and it also pays FICA tax. Now under an S-corporation most of that net profit will not pay FICA tax which is most of it is the social security tax.

So the main advantage of the S-corporation for active income businesses is that they save the 15.3% nasty FICA tax. Now rental income is passive income and passive income does not pay the 15.3 FICA tax. So basically there’s no tax advantage in placing your rental property into an S-corporation.

Reason number two that you do not buy rental properties under an S-corporation is that you lose the ability to be able to transfer the property out of the business without having to cause a taxable event. For example let’s say you have the rental property under a regular LLC. The regular LLC has the ability that you can take the property in and out of that LLC most likely without causing a taxable event.

Now if the business that holds the rental property is an S-corporation it can be an LLC but maybe that LLC files taxes as an S-corporation so it’s the same thing it’s an S-corporation for tax purposes. So if that rental property is under a business that is taxed as an S-corporation and you want to transfer that property out of that S-corp or out of that LLC that pays as an S-corp it may cause a taxable event and you want to avoid that. And the third reason that you don’t buy rental properties under an S-corporation and this third reason is the most important reason is that if you buy rental properties under an S-corporation you lose your step-up in basis.

Now what does that mean? If you buy a rental property under an S-corporation let’s say that you buy the property for $500,000 okay you have the property for many years now that property has a fair market value of a million dollars let’s say you die now your children are going to inherit that property that you left so if the property is under an S-corporation your children who inherit the property will not have step up in basis. What does that mean? You bought the property at $500,000. At the time of your death the property is worth a million dollars, but since the property is under an S-corp your children will inherit that property.  And let’s say that now they decide to sell it, so if they sell that property at the moment of your death when they file the tax return they inherit the property as if they paid $500,000 which is the amount that you paid for that property under an S-corp. So, if they sell the property now for a million dollars on their tax return is going to say that they inherited for $500,000 and they sold for a million. So, now they have a $500,000 capital gains and they’re going to have to pay taxes on that.  

Now, if your rental property is under a regular LLC that does not file taxes as an S-corporation when you die and your children inherit their property they do have a step up in basis now what does that mean. In the same scenario let’s say you bought the property at $500,000 under a regular LLC now you had the property for many years now the property is worth $1,000,000 you die your children will inherit that property. Since they don’t have that property under an S-corp your children will have a step up in basis that means that if they sell that property just after you die their tax return is going to say that they inherited that property at a million dollars. That’s the step up in basis because they will inherit that property at the fair market value of the time of your death. So, if when you died the property was worth a million dollars, even though you purchased for $500,000 on their tax return it is going to say I inherited their property for a million dollars and we sold it for a million dollars. This means zero capital gains that means zero taxes that your children are going to have to pay.  So there you have it, those are the three main reasons that you do not buy rental real estate under an S-corporation. So, we hope you have received valuable information in this video if you have like it and share it with another real estate investor that can take advantage of this information remember that we are freeram we can guide you and set up your business and your LLCs and we design the best legal and tax structure for your rental investments thank you for watching this video god bless you

SUMMARIZATION:

When it comes to real estate investment, one of the biggest mistakes we see investors make is purchasing rental properties under an S-corporation. At FreedomTax Accounting, we often advise against this approach. In a recent video, we highlighted the top three reasons why buying rental property under an S-corporation can be problematic.
The first reason is that there are no tax advantages. Rental income is classified as passive income, while S-corporations provide tax benefits to businesses generating active income. These benefits primarily stem from avoiding the 15.3% FICA tax. However, passive income from rental properties does not incur FICA tax, meaning there is no real benefit to placing rental property under an S-corporation.

The second reason is the potential tax liability when transferring property. If a rental property is held under a regular LLC, investors can typically move the property in and out without triggering a taxable event. However, under an S-corporation, any transfer could create a taxable event, leading to unexpected tax liabilities. This lack of flexibility can complicate real estate planning and asset management.

The most critical reason is the loss of the step-up in basis. When rental properties are held under an S-corporation, heirs may inherit the property at its original purchase price rather than the current market value at the time of inheritance. For example, if you purchased a property for $500,000 and its value grows to $1 million by the time of your death, your heirs may face capital gains taxes on the $500,000 difference if the property was held in an S-corporation. However, if the property was under a regular LLC, the step-up in basis allows heirs to inherit the property at its fair market value, potentially eliminating capital gains taxes.

Understanding these distinctions can save investors significant time and money. At FreedomTax Accounting, we help clients structure their investments to maximize tax benefits and avoid costly mistakes. Whether you are starting a real estate portfolio or managing existing properties, consulting with tax professionals can help safeguard your financial future.