An S corp can be a valuable structure for a business, offering streamlined operations and some potential tax advantages. An S corporation has less than 100 shareholders and can be a sole proprietorship or a larger company. This entity does not pay federal income taxes at the corporate level but instead passes income or losses to the shareholders to be reported on their returns. However, some states require S corporations to pay income taxes, including New York and California.
This tax structure can be an advantage, avoiding double taxing of revenue and potentially reducing self-employment taxes for small business owners. In addition to tax benefits, many small business owners and partnerships choose the S corporation to protect their personal interests from exposure. The sole proprietor can avoid personal liability for business losses with an S corporation structure.
Pass-through entities include S corporations.
Pass-through entities, including S corporations, benefit from the QBID (Qualified Business Income Deduction) that was part of the Tax Cuts and Jobs Act, passed in 2017. The TCJA reduced tax rates for many individuals and businesses and allowed a reduction of 20 percent in QBI for most pass-through businesses.
It’s helpful to note that some shareholders can offset personal income with S corp losses since income and losses pass through to the shareholders per their ownership percentage. However, the offset is limited by the shareholder's stock and debt basis and limitations due to passive activity. Income passed through from the S corp to the shareholders can either be classified as salary or distribution. S corp shareholders pay self-employment taxes on the salary portion but not on distributions.
How does the S corp structure affect the ownership of the residence?
Having the S corp own your residence may sound like a great way to get free housing, but it’s likely to attract attention from the IRS. Whether you are the only shareholder or one of many (up to the limit of 100 allowed) living in a house owned by the company is reasonably construed as income. As a principal, you would need to report revenue of the amount equal to the fair market value of the rent equivalent.
If the S corporation buys your home to use in the business (presumably, the business function is real estate rentals), then you would not be able to live there. On the other hand, if you sell your home to your S corp, you can claim the primary residence exclusion for capital gains (up to the limits), and the S corp will have a new basis. However, if you later want to repurchase the residence from the S corp, it would owe taxes on any appreciation following the purchase.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
