There are a lot of benefits to investing in real estate, but one of the biggest is the favorable tax laws. However, many tax benefits are only available to those who invest in real estate passively through long-term rental real estate. Investors who fix and flip or own vacation rentals are deemed active investors and are subject to different taxation. But there are ways for active investors to save big on their taxes by utilizing an S-corp tax election for their LLC. Here's how it works.
How an S-Corp can save on taxes
Normally, active investments, including short-term rentals or rehabs that are conducted in a limited liability company (LLC), are required to pay income tax, as well as self-employment tax, which is currently 15.3% of gross salary. By choosing an S-corp election when creating your LLC, you are only responsible for paying self-employment taxes on a "reasonable salary" and are able to pay the remainder of your income as a dividend, which isn't subject to self-employment taxes.
This means a fix-and-flip business or short-term vacation rental business that, for example, grossed $250,000 in a given tax year and paid a $100,000 salary to the LLC managing member or owner, would be subject to income tax in addition to $15,300 extra for self-employment taxes.
However, if you operate your business in an LLC with an S-corp election, you can still earn $100,000 but separate $50,000 as a salary and the remaining $50,000 as a dividend payment for the year. By structuring your salary in this manner, you're only subject to paying self-employment tax on $50,000, saving you $7,650 when compared to conducting business as a normal LLC.
You can save big, but heed the requirements
As you can see, an S-corp tax election can save investors thousands of dollars come tax time, but there are important requirements that need to be met in order to do so. An S corp must have established bylaws that are maintained through initial and annual director and shareholder meetings. Additionally, this election requires the company to issue stock to all shareholders and record all stock transfers and is limited to LLCs with 100 owners or less, all of whom must be U.S. residents.
If you think this tax election could benefit your business, talk to your accountant and see if you can amend your LLC to utilize this tax election, or establish a new LLC to conduct business as an S-Corp.