Rentals as a tax shelter

[greaper007]

We're small business owners that file under an S-Corp.    We finally started to make some real dough this year and decided to keep the money in savings instead of taking it as incomes or distribution.   Unfortunately, we didn't realize that this savings would still count as income at the end of the year.   Thus, we have a $9,000 tax bill.

So, I started to think, is there anyway I could move this cash into another company attached to our umbrella corporation?    I've wanted to get into real estate for awhile, but I never had enough money for a down payment, and as small business owners it was hard for us to qualify for a loan.    Could part of our business savings/profits be used as a down payment on a property and thus be exempted from taxes at the end of the year?

[Chiron]

(Disclaimer: I am not a tax professional.)

I'm pretty sure the answer to what you are trying to do specifically is no. A down payment on a house is not an expense that can be deducted from other income.  It's a capital expenditure that must be depreciated over time.

If you have an S-Corp, it doesn't matter if the money gets distributed or not - you still get allocated the income.  If you want to prevent it from being taxed, you should have look into funding a 401k or TIRA or other pre-tax savings account with it.

EDIT: Also, it's generally much easier to qualify for a loan in your personal name than with your business, especially if it has a short credit history.

[Daleth]

EDIT: Also, it's generally much easier to qualify for a loan in your personal name than with your business, especially if it has a short credit history.

And not only is it easier, but the loans you can qualify for are much better. Lower interest, longer terms, interest rates that are fixed for the life of the loan... better in every way.

[greaper007]

Thank you.   That's what I figured, but I'm always trying to come up with creative ideas.

[johnhenry]

I don't disagree with any of the advice given. 

If you have an S-Corp, you should already have control (within reasonable limits) to split payout of earnings between salary to yourself and distributions to yourself....with distributions not being subject to self-employment taxes.  If you or the S-Corp own any real estate involved in the business, you should explore having the S-Corp pay rent, which would be expensed and reduce net income, to you or another company that would hold and operate the real estate.  The advantage being that the rental income, whether reported by the same taxable entity, would be passive income.  You should seek the advice of a tax accountant in these matters, but as long as fair-market rates are used to set your salary and the rent, you may have the opportunity to move some of the S-Corps earnings from active to passive.

[Bobberth]

An S-Corp is a flow through entity.  Its taxes are your taxes at your income bracket.  If you own a business that makes widgets and you own the building, generally it is preferable to have the widget operations in a C-Corp and have the property in an S-Corp.  In the C you pay all the expenses you can and leave enough earnings to be taxed at a rate lower than your personal rate.  Then you adjust the rent the S charges the C to remove the rest of the income and to (hopefully) be taxed at a lower rate due to higher individual tax brackets over corp tax brackets.  This only works one way.  You can't split the income out of an S as it is your personal income.  You can do the same things ordinary income earners can do to defer taxes but you also have a SEP or I401k that would have higher contribution limits.  If you're really rolling in the dough, you could look into a DB plan to really sock money away but you would definitely want to consult with experts on that.  You can also invest in your business, pre-pay expenses or convert more expenses to business related instead of personal for the company side of your taxes.

Your situation is similar to reinvesting dividends and capital gains distributions in a mutual fund.  No you don't receive the cash but yes you still have to pay tax on it.  Next year you will be better prepared for the tax bill. 

[johnhenry]

An S-Corp is a flow through entity.  Its taxes are your taxes at your income bracket.........This only works one way.  You can't split the income out of an S as it is your personal income.

You are correct about S-Corp being a flow-through entity where taxes are concerned.  But an S-Corp can choose to pay a salary to one or more shareholder/employee.  In addition it can pay out "distributions" to shareholders.  So while it is true that any payments from the S-Corp to an employee/shareholder are taxed as "personal income" for that individual, it's also true that an individual pays FICA taxes on earned income (salary) and not on capital gains (distributions).

The following article points out that the IRS has no problem with this so long as the wages of the employee/shareholder are not set at an "unreasonably low level".

http://www.mgocpa.com/go/mgo/thought-leadership/articles/s-corporation-shareholder-distributions/

As a general rule, I think it's best to have real estate assets used in the business(es) held by an individual or separate S-Corp or LLC.  But short of that generalization, the best (most tax-efficient) business structure can be very difficult to determine without all of the facts and many projections/assumptions.  Best decision depends on how much money the business makes, and how much other income the owners/shareholders have.  For example, even C-Corps only pay 15% tax on the first $50K, and the higher corporate rate on income above that.  But most agree that C-Corps require more money and diligence to maintain properly.  And some structures allow distributions in unequal proportion to equity while others do not.