Is your real estate business starting to grow? Maybe you are consistently closing five deals a month or have noticed your gross income is rising. While growing a real estate business is new and exciting, it does come with some not-so-fun considerations, one of which is incorporation.
In this article, we'll explore the fundamentals of real estate agent incorporation, including the pros and cons and when this business move might make sense.
What Does Incorporation Mean?
Incorporation is a tax designation that creates a corporation for tax purposes. There are two types of corporations: c corporations and s corporations. A c corporation is an entirely separate entity that pays income tax at the corporate level, meaning profits are potentially subject to double taxation— first at the corporate level, then as dividends on your personal return.
Due to this double taxation, real estate agents commonly pursue an s corporation designation. An s corporation is a pass-through entity, meaning all profit or loss is reported on your individual income tax return. This structure can unlock favorable tax advantages.
The Advantages of Incorporation
Self-Employment Tax Savings
One of the main advantages is self-employment tax savings. Sole proprietors and single-member LLCs pay both self-employment and income tax. In contrast, s corporations only pay ordinary income tax on net profits, potentially saving you a significant amount.
Flexible Growth Options
S corporations offer flexibility to bring on partners, take business loans, and sell the business—advantages not found in simpler structures.
Continuity Options
In a sole proprietorship, the business ends with the owner. S corporations offer continuity, allowing ownership transfer and ensuring longevity of your brand.
The Disadvantages of Incorporation
Reasonable Compensation
Since s corporations pass-through income or loss with no self-employment taxes, the IRS wants to be sure you are paying taxes. As a result, you must pay yourself reasonable compensation, which is subject to payroll taxes. Working with a qualified tax accountant or using a real estate agent tax calculator are two ways to determine reasonable compensation.
Expanded Reporting Requirements
S corporations must file separate business tax returns and comply with more detailed reporting. This makes professional consultation essential.
Separation of Business and Personal Finances
Although you already should be separating business and personal finances, incorporation requires this. If the IRS audits your business return and sees personal transactions, you could be in serious trouble. Using a real estate agent expense tracker, like AgentXpense, is a great way to ensure separation.
How to Incorporate as a Realtor
- Create a Limited Liability Company:If you already have an LLC, you can skip this step. However, if you have no formal business structure in place, which is common for sole proprietors, you will need to form an LLC.
- Apply for an EIN: Next, you will apply for a Federal Employer Identification Number. This process is free and can be done through the IRS website during normal business hours.
- Complete Form 2553:Now, you will need to request to be taxed as an s corporation by filing Form 2553. Once the form is filled out, it can be mailed to the IRS or attached to your first tax return.
While the process may sound simple, it's wise to work with an accountant to ensure accuracy and compliance.
Summary
Does incorporation make sense for your real estate business? It's important to weigh the pros and cons before making the move. Whether or not you incorporate, using a real estate accounting tool like AgentXpense is essential for tracking your income and expenses.
