This is a difficult question regarding an idea I have to be able to circumvent the risk of having my S-Corporation involuntarily terminated from deriving a large portion of my income from rental properties based on IRC 1362(d)(3)(A)(B) &(C). My situation:
-Currently own insurance agency in an SCorp
-I just started buying up rental properties in my name.
- The income derived from these rental properties over the next few years will be large.
-The rental properties are not Apartment complexes where I would be taking an active regular active roll in the maintenance. Rather the properties are single residences, duplexes, and fourplexes.
- I would love to get the tax
benefits of an S-Corp by lowering my self-employment taxes. However, I do not want to involuntarily dissolve my S-Corporation or be liable for C-Corporation taxes because more than 25% of the S-Corp's income was derived from passive income
. In the next few years the income derived from the rental properties will be about 90% of the total income of the S-Corp.
Here is the solution I thought up:
1. Set up a few LLC's to hold the property. When I form them I write that the objective of the LLC's is to make money in the long-term through appreciation of real estate assets while hiring a Property management company to do all the work for the rentals. This will work will include: procuring tenants for the properties, hiring repair services, etc., etc. etc.....
2. I have my LLCs contract with my S-corporation to do the property management. In return for the professional management, the S-Corp will be entitled to payment of the net profit accrued from the rents. ------Side Note-- I would also have to think of a way to exclude the portion that I can write off for a depreciation expense. Maybe I could pass only the piece of income I would get tax-free based on the annual depreciation expense through the LLC to myself because it wouldn't be income that I had to pay taxes on anyways? I might have to go deeper into this question later -----
3. I then pay myself a salary to manage both my insurance agency and property management company in the S-corp and only am responsible for self-employment taxes in the amount of my annual salary because I take the rest as a dividend.
4. When I want to sell the properties out of the LLC, I can sell them subject only to long-term capital gains tax. Thus, I would avoid excessive taxes there as well.
My question is will this fly? Has anyone successfully done this? Even made it cleanly through an audit? I have no idea because I couldn't find this idea on the internet anywhere. I realize the IRS might frown on an LLC that has a ton of properties without generating any income until they are sold. However, I thought it would be feasible to say that the goal is to make money through appreciation without dealing without doing all the work of acting as a landlord. If you think there are holes in this idea please point them out. Also, please offer any solutions you can think of as well. Thanks, XXXXX XXXXX