Tax formations for Real estate and business owned in the U.S

The list below is an overview of the advantages and disadvantages from a tax perspective of different business formations for a property or business owner:

1. Sole owner Individual Ownership: Purchasing an asset as the sole owner. When choosing this option, all revenues and expenses are reported on Schedule E of your personal tax return.

 Significant advantages of choosing this option include:

1. Administrative Ease – No need to open separate bank accounts. No hassle involved with setting up a separate business entity, including submitting proper documentation and creating an operating agreement. Simply put, this option allows for much less paperwork and administrative tasks.
2. Financial Savings – No need to assume the costs associated with establishing a business entity. Additionally, only one tax return needs to be filed so it a cost saving option.

 Significant disadvantages of choosing this option include:

1. Putting your personal assets at risk in the event of a lawsuit: Should renters, guests or anyone else hurt themselves either directly or indirectly from your property, they can sue you personally, and potentially claim any or all of your assets as a result of the lawsuit. There is no legal separation between yourself and the property you own.
2. Exposing yourself to estate tax: Any individual, even those who are not American citizens, who holds assets in the U.S. at the time of his/her death is subject to estate tax. This includes owning property in the U.S. at the time of death. An Israeli citizen with property in the U.S. can claim an exemption of up to 60,000$ towards the estate tax, while American citizens can do so up to 5,120,000$ using the unified credit. Above the aforementioned values, the property owner can be taxed up to 35%.

To receive a detailed description of the advantages and disadvantages of this classification, click here.

3. Formation as a Limited Liability Corporation (LLC) with a sole owner: Buying property through an LLC of which you are the sole owner.  When choosing this option, all revenues and expenses are reported on Schedule C of your personal tax return

 Significant advantages of choosing this option include:

1. Separating yourself from the entity in the event of a lawsuit: An LLC allows you to shield yourself from personal liability if your business goes bankrupt or injures someone or otherwise runs into legal trouble. Your personal assets wouldn’t be exposed in the event of a lawsuit; only assets belonging to the LLC.
2. Tax transparency and lack of corporate tax: Profits are taxed as part of your personal tax income on your tax return (Schedule C), and are not subject to corporate taxes. Therefore, while you do receive limited liability protection just as a corporation would, you do not pay the taxes associated with a corporation. In contrast, an individual running a business in Israel is subject to the applicable corporate taxes and is then also taxed personally on the distributions he or she claims.

 Significant disadvantages of choosing this option include:

1. Social Security Payments: As a sole owner of an LLC, you are classified as “Self employed – sole proprietorship” and therefore are subject to self employment taxes of 13.3% from the LLC’s profits by filing a Schedule C.
2. Complicated laws and nuanced differences from state to state: There are certain cases where an LLC does not provide complete protection over an individual’s private assets. Additionally, if you plan on purchasing real estate in different states, it is advisable to look into the differences in how each state treats an LLC. There are states that collect additional taxes and/or fees for LLC’s.

To receive a detailed description of the advantages and disadvantages of this classification, click here.

3. Limited Liability Corporation (LLC) within the framework of a partnership: Buying property through an LLC in which you share ownership. When choosing this option, all revenues and expenses are reported through form 1065, and each partner receives form K-1 which details his respective profits for that fiscal year.

 Significant advantages of choosing this option include:

1.  Separating yourself from the entity in the event of a lawsuit and lack of company tax: See descriptions above for an individual owner of an LLC
2. Simple and cheap to establish: Compared to other options, establishing an LLC is significantly cheaper (Between 30$-200$, depending on the state in which it is established) and involves much less paperwork than an S-corporation. There is no need to set up formal meeting between partners or shareholders, and there is no need to set up bureaucratic bodies, such as a board of directors.
3. No social security taxes: As opposed to a privately owned LLC, where the owner is assumed to be an active member and is therefore subject to social security taxes, in an LLC with multiple owners, the owners are assumed to be passive and are not subject to self employment tax. Instead, they are taxed based on their type of income and their income bracket.
4. Ability to be formed by an individual who is not an American citizen: In contrast, all partners of an S-corporation must be American citizens.

 Significant disadvantages of choosing this option include:

1. Obligation to pay taxes on all profits and inability to collect profits as salary: Members of the LLC are subject to taxes on the profits of the LLC regardless of whether the profits were used to further invest in the LLC or whether they were distributed. Additionally, the profits are not considered salaries, which could lend itself to better tax conditions.
2. Delicate Lifespan: In many states, when one member of the LLC chooses to leave, the LLC automatically falls apart and must be shut down. However, the remaining owners may choose to open a new LLC under a new name.

To receive a detailed description of the advantages and disadvantages of this classification, click here.

3. S-corporation (Subchapter S): Buying property and registering it under an S-corporation. When choosing this option, all revenues and expenses are reported through form 1120s, and each partner receives form K-1 which details his respective profits for that fiscal year as a proportion of the amount of shares he/she owns.

  Significant advantages of choosing this option include:

1. Lower tax rates on profit distributions: Profits collected by an S-corporation are distributed as working income which is subject to normal taxation and is considered ordinary income. However, all profits above this are considered distributions and are taxed at a much lower rate.
2. Deduction of worker’s benefits: Since some of an S-corporation’s profits are transferred as salaries to its workers, all benefits conferred upon the workers can be deducted from the overall taxable income.

 Significant disadvantages of choosing this option include:

1. Complicated and expensive: By law, an S corporation must have a directorate, transcribed formal shareholder meetings and many other formalities that can be both complicated and expensive.
2. Additional Taxes: For example, payroll taxes and corporate taxes.
3. Only relevant for American citizens

To receive a detailed description of the advantages and disadvantages of this classification, click here.

3. Limited Liability Corporation (LLC) while choosing to file taxes as an S corporation: One must fill out Form 2553 when choosing this route. Revenues and expenses from each LLC are reported through form 1120s.

 Significant advantages of choosing this option include:

1. Ability to take advantage of the distributions tax benefit discussed above.
2. Your personal property is protected against lawsuits and you don’t pay corporate taxes.

 The significant disadvantage of choosing this option is:

Professional analysis of the tax benefits of this option: There are a number of complicated factors that play into the worthiness of this option, including the company’s revenues, number of stock holders, income as salary vs. income as distributions etc. It is advisable to hire a lawyer to fully understand the implications of choosing this option.