Understanding How You Hold Title to Real Estate – Part III

     This is the third in a three-part series on holding title. When you own real estate, the way you hold title affects how the ownership of your property can be transferred and how the property can be financed, improved or used as collateral—and ignoring this can cost you thousands of dollars in unnecessary taxes. This time, I’ll cover holding title via a corporation.

     As a reminder, I am not an attorney or an accountant. Consult those professionals about how to hold title. I am simply here to provide information to bring up for discussion.

     Last time, we talked about holding title via partnerships, both among parties with existing relationships and among unfamiliar parties who can pool their money and acquire title to investment property.

     The advantages of limited liability companies (LLCs), limited liability partnerships (LLPs), and S-corporations are that they provide others with whom to share financial responsibility and a buffer from legal liability. The disadvantages are the expenses associated with setup and administration. Note, while the federal government does not tax LLCs, LLPs, or S-corporations for income tax purposes, the State of California does. Even if the LLC, LLP, or S-corp loses money, the State of California will levy a minimum $800 income tax. Therefore, you’ll pay some tax even if there’s no income produced by the property.

     C-corporations also provide some protection from financial liability, for everything from slips and falls that occur on the property to the discovery of a toxic waste dump located under the main building. However, C-corporations are more burdensome and expensive to administer. You wouldn’t create a C-corporation simply to hold title to real estate, but if the corporation already exists, it may make sense to put title in the corporation’s name—especially if that’s where the corporation does business.

     If a C-corp has enough profit, those profits can either be distributed as salary or they can be distributed as dividends (or they can simply be left in the corporation and reinvested). The IRS wants its chunk of flesh regardless. So, if you take all the profits out as salary and that salary isn’t justified by the scope of work you’ve done, the IRS will reclassify that salary as part salary and part dividend, thereby creating a tax liability for the corporation based on the dividend. This means the corporation is paying taxes and you, as an individual, are also paying taxes on that dividend amount. In essence, the IRS gets to double-dip at your expense.

     The smart choice is often to own a property as an individual and lease it back to the company or corporation. This avoids unnecessary tax burdens and paperwork, as well as retaining depreciation for your personal income tax return at a better rate than the corporate return would allow. While these corporate structures can shield property owners from some liability, if owners don’t follow the corporate rules to the letter, a claimant can pierce the corporate veil and come after the owners’ personal assets.

     I knew a guy who co-mingled his personal and corporate funds. He allowed his corporation to go bankrupt but was a personally wealthy individual. His company had rented space from me and then insisted he couldn’t pay rent because the company had gone bankrupt. Because he didn’t follow the rules, I was able to pierce the corporate veil and collect $45,000 in “uncollectable” rent. So, a word to the wise, if you want to take advantage of corporate liability protection, follow the rules relentlessly.

     Again, this column is food for thought. I have barely scratched the surface on this complex topic. Talk to your lawyer and accountant before making any legally binding decisions.

     If you have questions about property management or real estate, please contact me at [email protected] or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.

Dick Selzer is a real estate broker who has been in the business for more than 50 years. The opinions expressed here are his and do not necessarily represent his affiliated organizations.