Real estate can be an attractive long-term investment. But the legal entity you select to own property can have important tax implications. Here’s why single-member limited liability companies (SMLLCs) are generally a better alternative than corporations from a federal income tax perspective.
Tax Benefits for Disregarded SMLLCs SMLLCs — limited liability companies with only one owner (member) — are popular vehicles for business and investment activities. Why? These entities offer federal income tax advantages along with liability protections similar to those of corporations.
Specifically, under the “check-the-box” IRS regulations, an SMLLC can generally be disregarded for federal tax purposes. Exceptions include:
- When you elect to treat an SMLLC as a corporation for federal income tax purposes (relatively rare) and
- For purposes of federal employment and certain excise taxes.
By not treating an SMLLC as a corporation, it gains disregarded entity status under tax rules, simplifying the tax process. The IRS treats the entity’s business or investment activities as being conducted directly by the SMLLC’s owner. This means there’s no need to file a separate federal income tax return for the SMLLC; income and expenses are reported on the owner’s return. For example, if an individual owns the SMLLC, rental activity is reported on Schedule E of the individual’s tax return. A similar treatment applies to SMLLCs owned by corporations, partnerships, or multi-member LLCs treated as partnerships.
Liability Protections Although a disregarded SMLLC is ignored for federal income tax purposes, it’s still recognized under general state law, providing liability protections under the applicable state LLC statute. These protections are often comparable to those offered by corporations. Real estate investors, in particular, value this structure for shielding assets from potential liabilities — from environmental issues to personal injury claims from tenants or visitors.
Additional Tax Advantages For federal tax purposes, the owner of a disregarded SMLLC is considered the direct owner of any real estate held by that entity. Thus, when property owned by the SMLLC is exchanged for other real estate, it’s treated as a direct exchange by the SMLLC’s owner under the Section 1031 (like-kind) exchange rules. IRS private letter rulings have confirmed that property swaps involving SMLLCs qualify for Sec. 1031 treatment. If you own real property and plan a Sec. 1031 exchange, consider establishing a disregarded SMLLC to receive the replacement property. This setup qualifies for Sec. 1031 treatment while providing liability protection for the replacement property.
The IRS has also ruled that property owned by a disregarded SMLLC is treated as owned directly by the owner for Sec. 1033 tax-deferred replacement rules. These apply to property involuntarily converted due to condemnation or destruction.
Beware of State and Local Tax Issues While a disregarded SMLLC offers federal tax advantages, be mindful of state and local tax implications. For instance, Texas SMLLCs must pay the state’s corporate franchise tax, though individuals and partnerships are exempt. Some states impose annual registration fees or require separate state income tax returns for SMLLCs.
On the other hand, using a disregarded SMLLC can sometimes be beneficial under local tax rules. In one case, a taxpayer acquired a disregarded SMLLC that owned the replacement property for a Sec. 1031 exchange, allowing them to avoid local real estate transfer taxes while still qualifying for a direct acquisition under federal tax rules.
Putting an SMLLC to Work for You Disregarded SMLLCs aren’t just advantageous for individuals who invest in real estate. All types of investors — including corporations, partnerships, and limited liability companies — can enjoy the tax and legal benefits associated with these entities.
While single-member LLCs offer significant tax and liability advantages for real estate investments, determining the best structure for your assets requires a thoughtful approach. Our tax advisors at Reynolds + Rowella are here to provide personalized guidance on structuring your investments to maximize tax benefits while addressing potential state and local tax considerations. Contact us today to see how we can support your investment strategy with tailored tax and entity planning.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
