Updated December 20, 2021
Your business entity matters. Although it is often a mere afterthought, choosing the right entity for your rental property business is the foundation of your property investment future. Much like the foundation for a house, if the proper entity isn't selected, the entire structure could be weak—or even collapse, given the wrong circumstances. The good news is that even if you own four, five, six, or more rental properties, it's not too late to select a business entity in Dallas.
An essential examination of the details around four entity options will help you make a financially sound decision and set your properties up with better financial protections. You probably know that an airtight lease agreement and quality tenants are critical to keeping properties in excellent condition and boos returns. However, today our Dallas rental property management company looks at sole proprietorships, partnerships, C corporations, and limited liability corporations (LLCs) and how each one provides critical protections. We'll also discuss the tax ramifications for each entity—so you can figure out how to save the most money—as well as some of the other benefits.
Sole Proprietorships and Partnerships
Property management companies will tell you that incorporating your rental properties is one of the best ways to protect your investments and income. For tax purposes, sole proprietorships and partnerships are essentially the same. All money made by the business is income for those who own the company; funds will incur taxes like ordinary income.
Benefits of Sole Proprietorships and Partnerships
What are the benefits of a sole proprietorship or a partnership for your real estate investments? An investment property benefits from:
- Simple structure. There is no separation between you, your partners, and the business. Therefore, you don't form a new entity.
- Easy to set up. Although the initial process and expenses depend on where you are, getting things rolling is easy and cheap.
While simple can be good, property managers know that simple isn't always the best protection for a real estate investment.
Drawbacks of Sole Proprietorships and Partnerships
What can go wrong with these simple configurations? A professional property manager advises that:
- Your assets and income are exposed. If the business gets sued, you get sued—and you could lose everything.
- There are no options available to help you get extra tax savings. Although you can deduct expenses, there are no special business tax protections in place if you have a sole proprietorship or partnership.
What are the other options for property owners in Dallas-Fort Worth? While different corporations or LLC can be more complicated, they can be worth considering to minimize financial risks.
When you form a C corporation, your Dallas business becomes an entity. This classification means it gets treated like a person with taxes to pay. It also means that if the company gets sued and loses, it pays for the loss with its own money—not yours. Therefore, your personal income and assets stay separate from your rental property assets.
Here's a closer look at the tax situation faced by a C corporation:
The corporate entity can enjoy a flat rate of 21% on its profits. If a person makes between $19,050 and $77,400 each year, they're only paying 12% in taxes. If that's the case with you, you would be paying 9% less than what the corporation would be paying. However, assuming you make more than $77,400 each year, you're paying at least 22% in taxes. So if you make more than $77,400 each year, it would appear that forming a C corp would be a great idea! Not so fast—you have to take into account double taxation.
Double taxation occurs when the corporate entity gets taxed, and then a property owner gets taxed when you take some of the money the corporation makes. The payment you receive is considered a dividend. As a result, if the corporation makes money and you take some, the amount you take is taxed at the rate set for dividends.
The income you make from your rental corporation—if it's $77,200 or less—doesn't incur a dividend tax. However, any amount between $77,201 and $250,000 gets taxed at a rate of 15%.
If your rental corporation pays you an amount between $250,001 and $479,000, you pay an extra 3.8% Medicare tax on top of that, which results in an effective tax rate of 18.8%. And if you receive $479,001 or more, you pay 20% plus that same 3.8% Medicare tax for a total of 23.8%.
Benefits of a C Corporation
What do residential property managers say are the benefits of a C Corp?
- Low taxes. If you live a simple life with low expenses, less potentially taxable money is taken from your C corporation.
- Your property and other assets are protected. If the business gets sued, it can lose—but you can escape most of the damage.
- Fringe Benefits. When you work as an employee of a C corporation, rental property owners have access to fringe benefits that the C corporation can deduct from its income. Some of the fringe benefits include health and other insurance, medical expenses, deferred compensation plans, and company-owned cars.
While a C Corp can be appeal to real estate investors, it's important to consider the potential issues that come with this type of incorporation.
Drawbacks of a C Corporation in Dallas-Fort Worth
While a C Corporation offers more protections when real estate investing, it also has plenty of drawbacks, including
- Double taxation. As we mentioned, a real estate investor can get taxed twice; once when the C corporation makes money and once when they take money out because it's considered a dividend.
- No pass-through tax deduction. If you have an LLC, you can deduct 20% of the LLC's income from your taxes. This isn't possible with a C corporation.
- More record-keeping. The best property management companies can help you keep records of the meetings you have.
- More tax paperwork. Investors have to file taxes twice, once for you and once for the C corporation.
Is there a better option than the minimal protections of a sole proprietorship vs. the drawbacks of a C Corp? Many Dallas property management experts recommend an LLC for investors!
Limited Liability Corporations (LLCs) for Property Owners
An LLC (limited liability company) is often seen as the structure of choice for a rental business. It is considered a "pass-through" entity, which means its profits and losses pass through to the property owners. Investors get taxed according to these profits and losses. You also gain protection for your personal assets if the business gets sued.
How the Pass-Through Deduction Works
An LLC has a chance to pay 20% less on its net income. If you form an LLC and are in the 24% tax bracket, you may only have to pay a tax rate of 19.2%. If you had formed a C corporation, you would have paid more—21%.
Benefits of an LLC
A company that delivers professional property management services works with many property owners throughout the Dallas-Fort Worth area. We often recommend an LLC due to:
- Tax savings. With the pass-through deduction, you are in a good position to pay less money in taxes than you would as a sole proprietor, partner, or owner of a C corporation.
- Protection of your assets. Personal assets sit comfortably behind the shield of the LLC structure.
As with any business entity, even an LLC has some drawbacks to think about.
Drawbacks of an LLC
A property management team can walk you through these concerns when operating properties as an LLC.
- It can be costly to set up. The amount you pay differs depending on where you live, but it can be several hundred dollars a year. However, in Dallas, you pay a setup fee of just $100, making an LLC an affordable (and smart) choice for real estate investing!
- Keeping good records. Property owners must keep good records of meetings and transactions.
- More tax paperwork. If you have multiple members in your LLC, you'll have to file taxes twice: an LLC tax return and a partnership tax return.
In most cases, these "drawbacks" are merely headaches that a full-service property management company and your accountant can walk through with you each year. Real estate investors usually find that the benefits and protections of an LLC far outweigh the hassles!
Choose a Dallas Property Management Company to Protect Rental Properties
Considering the protections an LLC offers, the relatively low setup cost, and the tax savings, it's no wonder why LLCs are a popular option for property investors in Dallas! However, to make the best possible decision, you should sit down with your accountant and go over the numbers.
Regardless of which entity you choose, if you do so thoughtfully, you are putting yourself in a position to build a strong financial foundation. In addition to the right business entity, owners should also consider the best property management service in Dallas Ft Worth! With experts to handle tenant screening, collecting rental payments, property maintenance requests, and the eviction process, rental properties and owners experience the best protection for long-term success. RentHub works with new property owners and experienced investors to deliver the best property management in Dallas!
Reach out to the RentHub team to help manage your investment properties!