Why Owning Real Estate in a Corporation's Name is Not a Good Idea
Owning real estate in a corporation's name is not a good idea from both a tax and liability standpoint.
1) Double taxation:
A regular C corporation is not a pass-trough entity.
Corporate taxable income is initially taxed at the entity level (the corporation pays taxes). After-tax income is called retained earnings.
If the corporation distributes its retained earnings to it's shareholders as a dividend, they must include the dividend in their individual income tax return where it is subject to taxes a second time (at the personal level). Hence, double taxation.
If an asset that appreciates in value is held inside a corporation and the asset is subsequently sold by the corporation, double taxation will occur when the after-tax income is distributed to shareholders.
- You own property in your C corporation.
- The C corporation sells the property and realizes a gain of $10,000.
- The corporation's income tax rate is 15 percent.
- Corporation income tax is: $1,500 (15 percent x $10,000).
Continuing with the example...
- The C corporation pays you a dividend of $8,500 (the gain of $10,000 minus the $1,500 in taxes).
Assume your personal tax rate is also 15 percent.
- Your personal income tax is: $1,275 (15 percent x $8,500).
Total Tax Paid:
- $1,500 plus $1,275
- That's almost 28 percent of the $10,000 gain ($2,775/$10,000)
Now assume the same facts, except, your organized as an LLC (a pass-through entity):
- Assume your personal tax rate is 15 percent
- Your tax is $1,500
- 15 percent x $10,000 gain
- The LLC entity is not subject to tax
- You save $1,275 by being organized as a pass-through entity rather than a C corporation.
Note: In the above example, I assumed a corporate tax rate of only 15 percent.
However, if the corporation was in a higher tax bracket it would have paid taxes at the higher marginal rate because all C corporation income is taxed at regular corporate tax rates. The lower capital gains rates do not apply to C corporations.
In addition, if your personal tax bracket is higher than 15 percent, the gain would be taxed to you at the lower capital gains rate of 15 percent.
By operating out of a pass-through entity, you get the benefit of the lower capital gains rates.
Owning Real Estate in a Corporation:
If you own real estate inside a corporation you could lose property owned by the corporation should you be sued personally or if the corporation be sued.
For example, if you own an office building and someone slips on the lobby floor because your maintenance worker failed to mop up a spill from a broken bottle, the corporation could be sued.
If the corporation does not carry sufficient insurance to pay the claim, the judgment creditor may end up owning the corporate stock. By controlling the stock, the creditor can sell the building.
If the claim was for $2 million and your insurance covered only $1 million and your corporate-owned building is worth $500,000, the building could end up being sold to satisfy the claim.
Your personal assets would be protected since the lawsuit was against the corporation. But, you lose the building.
Owning Real Estate in an LLC:
The Charging Order -
When you own property in an LLC, partnership, or limited partnership, property in these types of entities are protected if you are sued personally.
This protection is due to the collection limitations placed on a judgment creditor via the charging order.
What this means is, say you own property in a multiple-member LLC with one or more members, and you are personally sued. You lose the suit.
The judgment creditor may obtain a charging order from the court allowing the creditor to pursue collection of his claim against YOU (not the LLC entity and not the other LLC members).
However, the judgment creditor is limited in his collection efforts because a charging order only gives a judgment creditor the right to attach your interest in LLC distributions.
This means, LLC assets remain out of the reach of the creditor. Which in turn, means, the LLC, as a business entity, may continue operating without disruption and with its assets in tact. And this is the whole point of the charging order:
- To protect NON-debtor partners from claims against a DEBTOR partner.
A judgment creditor may not vote his charging interest or participate in the management of the business either.
These restrictions preclude a judgment creditor from voting for an LLC distribution, which would allow the creditor to get his hands on some money.
Simply put: If no LLC distributions are made, the creditor gets zero. No money, no chance at selling LLC assets, nothing!
The advent of the charging order dates back to around 1914 in the United States. It was is designed to protect NON-debtors partners from claims against a debtor partner.