Choosing the Right Business Structure for Real Estate: Tax Considerations

Published: Jul 17, 2024
By: Steven Barranca; Gregory Booth
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When it comes to real estate investments, selecting the right business structure is crucial. Each has unique tax implications that can significantly impact your bottom line.

In this article, we’ll compare C Corporations, REITs, S Corporations, and Partnerships, explaining the tax treatment of each, its advantages, and other considerations to remember when choosing the best option for you.

C Corporations

While C Corporations offer limited liability protection and the ability to raise capital through stock offerings, they come with a significant drawback – double taxation. The corporation itself pays taxes on profits, and shareholders are taxed again on any dividends they receive. This double tax hit can eat into your overall returns. Additionally, the administrative complexity makes them less than ideal for smaller real estate ventures.

Real Estate Investment Trusts (REITs)

These pass-through entities don't pay corporate income tax themselves, instead distributing at least 90% of their taxable income directly to shareholders. While REITs offer diversification through publicly traded options, you sacrifice some control over property management decisions. Maintaining their tax status also requires adhering to specific investment and distribution requirements.

S Corporations

S Corporations are another pass-through entity. Shareholders report the company's profits and losses directly on their personal tax returns, avoiding double taxation. S Corporations provide limited liability protection but. ownership is restricted (foreign individuals cannot be shareholders, for example) and limited to one class of stock.

Partnerships

Partnerships provide the most flexibility in terms of profit and loss allocation and even allow including partnership liabilities in your tax basis. There are no restrictions on ownership, making them suitable for various investor structures. However, managing multiple partners can be complex, and disagreements can arise.

Choosing the Right Business Structure for Real Estate

Choosing the right business structure requires careful consideration of your investment goals, risk tolerance, and tax implications. To help you navigate this decision, the following quick comparison chart summarizes the key considerations for each structure type:

Quick Tax Comparison Chart for Business Structures

	C Corporation	REIT	S Corporation	Partnership
Limitation on Ownership
Limitation on number of shareholders/partners	No	No	Yes	No
Limitation on type of shareholders/partners	No	No	Yes	No
Limitation on number of shareholder classes	No	No	Yes	No
Entity Level Taxation
Corporate / partnership entity subject to income tax	Yes	No (subject to exceptions)	No (subject to exceptions)	No (subject to exceptions)
If a C Corp is converted to a REIT or S Corp, must appreciate property be held for at least 5 years to avoid entity-level tax on the gain from the subsequent sale of the property?	N/A	Yes	Yes	N/Z
Shareholder / Partner Taxation
Amount subject to taxation	Dividend payments	Dividend payments	Allocable share of taxable income	Allocable share of taxable income
Must cash flow be distributed pro rata?	No	Yes	Yes	No
Can profits/losses be specially allocated?	N/A	N/A	No	Yes
Can shareholders/partners deduct losses?	No	No	Yes (subject to limitations)	Yes (subject to limitations)
Can shareholders/partners get basis for their allocable share of entity-level debt?	N/A	N/A	No	Yes
Can shareholders/partners get basis for their allocable share of entity-level debt?	N/A	N/A	No	Yes

Partnership

By understanding the strengths and weaknesses of each structure in relation to your specific situation, you'll be well-equipped to choose the one that best positions your real estate investments for success. Remember, our tax advisors can help you navigate your specific circumstances. Connect with our team below to get personalized advice.