90% of Real Estate Professionals Don't Know This

I think 90% of the investor rooms got the wrong entity in the wrong state doing the wrong thing.

Using an LLC taxed as an S corp for a rental property is like using a fork to eat cereal. You pay income tax and you also pay self-employment tax on that income, which by the way is 15.3%.

There's operations and assets, and we want to wall down the middle. Holding company on the right, operation company on the left. Leave them alone.

It's going to result in the least amount of tax and the maximum amount of asset protection.

Welcome everybody to the Main Street Business Podcast. My name is Mark Kohler, here with the incredible Matt Sorenson on the heels of the release of his new book. If I didn't plug it, you know, do I get an affiliate link? Like if someone buys it from the show, can I make money?

I'll buy you some rolled tacos.

I know. I was like, can we get this podcast done? I got some rolled tacos waiting for me with some drenched in guacamole. He's like, you got to get your work done first. Okay, Mom. Dad. All right, okay. So our topic today, you realtors— I was just at a conference in Nashville and it was always so exciting to see people like astonished and excited about something I take for granted. I just felt like 90% of the room didn't even know some of these topics. I mean, that happens to you all the time.

Yeah, and I think when we say 90% don't realize this is 90% of people who are in the real estate space are set up wrong in one way or another. They might have the wrong state, the wrong tax, the wrong entity type, the wrong structure of multiple entities, the wrong documents. Like, it's— as, as a— as business and tax lawyers, as Mark and I are, we can get a little specific on how to have it 100% optimized. Some of you are operating it at 10%. Some of you are halfway there. But we want to get all of you with the most optimal structure that's going to result in the least amount of tax and the maximum amount of asset protection.

Love it. And I'm going to say it another way here so that all of you that think you've got your shiz together, hear me out again. I think 90% of the investor rooms, real estate professionals, realtors, brokers, whoever I go to in that real estate space, they view— they've got the wrong entity. In the wrong state, doing the wrong thing, and it's incorrectly set up and not maintained. Now, if you're— that I rolled off 5 things there. Now we're going to go through it in different angles here, peel away the onion. But if you can say, nope, I got the right entities in the right state doing the right thing, properly structured, owned by my trust, owned by this— I mean, there's about 5 or 6 things. If you hit— you could check those boxes, you get an A today. If not, you got some work to do. We're gonna save you money, make you money.

Yeah, and we'll get you there. We will get you there. So let's talk about entity. I mean, this is the foundation of your business. You're running your income through there. You probably set it up to limit your liability so that all of this operations and stuff you're having isn't risking everything else you're trying to build in your life, your assets, your investments, the equity in your home, your retirement accounts, right? We wanna isolate that risk. So we gotta make sure we're getting this Yes.

Like what entity does what? Like, that's just basic. And I know it sounds basic, but it can get screwed up real quick. So before we talk about states and ownership and blah, blah, blah, even taxes, what do you— what do entities do? Can I take first bite?

Yeah.

Okay. An S corp or an LLC taxed as an S corp— people use the right terminology, you'll screw someone up. Someone yesterday said, well, I have an LLC under an umbrella of an S corp. I'm like, what? What are you talking about? Okay. Oh, you mean an LLC taxed as an S corp, I guess. Okay, so everybody, we use S corporations, whether it's an Inc. or an LLC taxed as an S corp. That S corp is for operations, fixing, flipping, rehabbing, commissions, sale of product, sale of service, property management. If you're getting paid to do something it's going to be a different type of tax rate. It's going to be called ordinary income. And you want it to go through an S corporation. S corp's not going to own assets. You should never own assets besides your laptop and a cell phone. Maybe some— if you're a contractor, we can get into the equipment issue. But let's just say it really doesn't own anything.

Depreciating assets.

Exactly. Yeah. Real assets, real property assets. So personal property, fine, whatever. Okay, so this S corp is for operational income.

The end.

And in our trifecta, we'll get there. We'll show you where it goes. But the first thing to know is if you have an LLC taxed as an S corp, you have an S corp. Do not walk around going, oh, I got an LLC and I got this. Do you have an S corp?

Yeah.

And call it an S corp. Even though the LLC at the end of the name doesn't change, once you make it an S corp, it turns from blue to red. The end.

Yeah. Now, one thing we— and I'll say another reason you might have an S corporation or— sorry, you might have an entity here, not necessarily an S corporation, is you might own real estate. That's the single-family rental. It could be duplex, it could be multi-units, commercial, retail, short-term, long-term, doesn't matter. It's an investment property, right? And so you likely would own that in an LLC. Now you might have an LLC taxed as an S corp for your operational income. This LLC to hold this rental property, this real estate, you're in the real estate business, you're probably seeing some good deals and should be investing in the stuff that you know. So maybe you're acquiring some rental properties. Those are in a separate entity. Now that LLC is very different than the LLC that would have an S election to it that you are using for your operations. Think of these as like tools. I was gonna go with the utensils example. Okay.

Okay. Okay. See if utensils. Okay.

All right. So using, okay, let's see if you like.

I'm so nervous for this. Let's go there. All right. Okay. Like the College Roommate that's like, oh, go do it. Yeah. Let's hear it. All right, so here we go.

Using an LLC taxed as an S corp for a rental property is like using a fork to eat cereal. Do it. It's not really getting the job done. There's a better utensil.

I'm trying to figure out what utensil is a plain old LLC. I love it. Okay. So in this example, I'm what? No, no. Yeah. In that example, the spoon would be the S corp. But anyway, all right. I'm going to say this too. And I actually put Matt in a hard spot because the S corp's easier to explain than the LLC because the LLC can be used for anything. So it is harder. What you're trying to do is describe, well, you can have an LLC that does different things. An LLC can be taxed as an S corp, an LLC can be for a partnership, an LLC can be a single-member LLC, it can be a two-member LLC. So the LLC does get a little more complicated. So I'm going to say it one other way.

The—

what we're trying to have you all understand is there's operations and assets and we want a wall down the middle. And this is where we start to build the trifecta. On the left side, you're going to have operations, preferably one entity taxed as an S corp. And then on the right side, you start getting these LLCs that can look very different. But the LLCs are for holding assets. So you have a holding company on the right, operation company on the left. Leave them alone. They're separate. The end. We're going to talk about where you set them up, but you just need to know first you've got these two tools in the toolbox. Yeah, the drawer. Use the spoon for cereal, use the fork for fried rice. You know, like two different things.

Yeah, I was gonna go down the chopstick route.

That's not even going— that was not a good one.

That's gonna go— this is spiraling down like, you know, the toilet bowl. Okay, good. So, um, but now here's an important point. This is, this is another really common mistake is The ownership of those two things, this left side, right side, does not connect between the entities. The only connection we have between the two is you or your trust is the underlying owner of each. But one of those LLCs does not own the other. Yeah, some people think of holding companies and they think, well, I've got this LLC doing my business and I'm getting my commission income and selling goods or services. That entity will own a separate LLC that owns the real estate, and that way I've got asset protection for that rental property. No, no, no, no. That's not what we're doing there. There's zero reason to do that. There's tax problems of how you just structured that. There's also asset protection risk, 'cause now we're putting all of our eggs in one basket by connecting the ownership there at the entity level. We want to separate it. So these are brother-sister companies having the same parent, you here, that's the owner of it, or I should say your trust. I like it.

Now, so we can get through some of the problems of where, how they're used, whatever. Please know we have another podcast on S corporations where we just talk about why you use the S corp, how you use the S corporation. Maybe we'll record them in the next couple weeks. We ought to do that. Just an S corp video. We do one almost every year where we just unpack an S corp. The LLC for holdings. We talked about when to use a Wyoming entity or not and all that. So holding companies are different from ops. We'll have different podcasts where we can zoom in on those. Now let's just— now, once you understand LLCs without an S election are for holdings, or I have an S corp for operations, there's one more variable here too. LLCs for partnerships. Matt and I have an LLC that— well, we have an LLP, LLC, same thing generally, but go with me on this. We have an LLC for our law firm. But our S corps own it because we don't want to have a corporation together. We generally are not going to have partners in an S corporation. Husband and wife's fine, but partners in an S corp gets to be very clunky too. I'll talk about that on the S corp podcast in detail. But the point I'm trying to make is have one S corp in your life. If Matt calls me up and says, hey, I want to open a title company too with our law firm, I'll say, great. I'm not going to do it. My S corp will do it. So my S corp can be a partner in a law firm. It can be partner in a real estate development. My S corp could be a partner in an education project, construction business, construction. Yeah.

So spec home.

Yeah. And if you're a realtor, you're going to have an S corp that might be a partner in a property management division or a brokerage or things like that. So you have one S corp They can be a partner, but those entities themselves are just shells, not to hold an asset, but to hold a relationship. And that relationship would be a partner in an operational business. Now, that was a little deep. Yeah, we're going to give you a resource here at the end to get your structure figured out. But what do you think? Do we describe enough entities?

Yeah, we say—

or no?

Yeah. When you say shell, though, I mean, that is an actual business. Take the property management company that would be popular for a lot of real estate professionals as they start doing property management. And, and you might have a couple other agents or brokers that go in on that with you and you're all sending work there and clients, but you've got more property management staff that are employees of that partnership. And, and so that entity would receive its own income, pay its expenses, pay its employees, and spit down the profits to your S corporation. You don't take a salary out of that partnership entity. That's the property management company. It's paying your share of profits down to your S corp. And you're taking a salary out of your S corp and then distributing profit. And the S corp is saving on self-employment tax. That's one of the strategies there. Again, for another podcast. Okay, so partnerships in the mix. We know S corp for operations, commissions, selling goods or services. We know— or that could be LLC taxed as S corp. We know LLC for asset holding.

Yeah. So here, can I go to this one here? Because here's what happened to me yesterday. I was in the hallway after one of the breakout sessions I taught is great, very successful realtor, a woman, and her husband helps in their real estate business. She goes, well, we have 3 LLCs. I'm like, okay, where do you live? California. Okay, but we don't have any entities in California because, you know, my husband hates California. We don't like, you know, we just like to live there, but we don't want to do business there. But you're doing business there. Yeah, just not putting your entity there doesn't solve that problem. But anyway, What we started to unpack was first, oh, one of them's an S corp, LLC taxed as an S corp, and the other two were for rental properties and registered in Wyoming and Florida. No, the properties were not even on title because they were concerned about the due-on-sale clause with the loans. I mean, it was just— and she was, she was kind of better. She was like, we're a hot mess. Like, we've got all this stuff moving around. But I— that's why I said to Matt, we got to talk about this on this podcast because so many people like like they set up these entities and they think they're doing— and but then on day 2 they're like, I don't think it's structured right. So the next point I'm just making is once you have the right entity doing the right thing, let's make sure it's set up in the right state. So I'll just say, if you're doing an S corp, you're going to have that S corp set up in the state where you're doing business, you're operating, even if you're working out of your home. Wherever you live is where you're—

California Yes, I'm sorry.

Pay the $800, people.

Yeah. Yeah. By the way, the state of California literally has guidance in their franchise tax statute publication that's out there that says, hey, by the way, you know, you got to pay $800 minimum tax for LLC or an S corporation. This is your minimum gross receipts tax. And, and, and even if you have this rental property in Missouri and you have a Missouri property manager and a Missouri LLC, if you made a phone call from California to your property manager in Missouri about your Missouri LLC and your Missouri rental property, your LLC did business in California. You need to pay us $800. So that's how aggressive they are. To think that earning commissions in that state, you're not going to get into their grasp is— it's a little generous. So just know you've made a, you've made a, um, you've negotiated and you've, um, made a compromise if you live in California. Yeah, that you will tolerate that BS because you've got the beach, you've got the weather, in and out.

Yeah, you know, all those good things that you enjoy California for, you, you have to pay for that. So, okay, now with no more beating up on California, but just so I like that you brought up Missouri. Let's stay with that example for a moment. Bookend this. If I live in California and I'm operating as a realtor, a real estate investor, a professional fix and flip or rehab or whatever I'm doing, construction, I'm in real estate in California. Your S corp, LLC taxes, S corp will be registered in California. But I have a rental property in Missouri. Okay, well, I'm going to set up a Missouri LLC and I have a rental property in Tennessee and a rental property in New Jersey. Okay, you set up LLCs in the state where those properties are. Well, I heard about Wyoming. Well, come there. Chill. But step, step one is the entity has— that's going to be on title for that rental property has to be registered in that state, even if it's foreign registered. But it's not going to be the same entity that you're doing your S corp in. So S corp does ops, you set up an LLC in the state where the rental property is going to be. That's level one.

Yeah. And even Arizona, I have rental properties here in Arizona with Arizona LLCs, I have my Arizona S corporation because I'm doing business here and the rental properties here, but rental properties in Indianapolis, it's an Indiana LLC. Okay, so we're going to set up the LLC in the state where it's located. Now, let's say you're in this scenario, though, where you have the LLC in the wrong state, but you've been filing tax returns for it. You've been operating your bank accounts there. You've been using the name everywhere. You want to keep it, you do have one option. You can do something called a domestication. Now, this is not cheaper than doing a new entity. This is actually more work than setting up a new entity. But what the process is, is we take that entity. Let's say this— what state did she have her?

Wyoming LLC.

Wyoming LLC taxes an S corp, and we would file foreign into California. Then we would, we would convert that foreign registration to what's called a domestication. Which means, hey, I am XYZ Inc. now in California and it's a California entity and you would dissolve in Wyoming. Okay. That would be a way you keep the same entity. We obviously set up a new entity in the right state and you start over. But there are ways you can keep the same entity. You might have payroll in place with employees and other stuff. You might have bank or a line of credit against that. You might have other stuff, vendors, whatever, that it's a pain to restart. And so you can look at doing a domestication of the entity into the right state.

I love where you went with that. And now some of you're— I know, I know you because I've been teaching this topic for 25 years and worked with thousands of real estate professionals. And I know what you're feeling right now. Overwhelm, confusion. Guys, you're not— you're— this is too much. Hang tight. Hang tight here. Just keep— you got to absorb a little bit and it's all going to click. And when it clicks for you, it could be very different than someone else. And that's okay. Keep listening here because I want to say we'll give you a solution of how to bring together at the end, affordable, very affordable solution. But the Wyoming thing, let me just say, some of you have heard, if you've been on the web, been to an influencer's event in the last 2 years, not hiding under a rock, someone's going to say you got to have a Wyoming entity. Now, why? Well, Wyoming is very affordable to set up. I can make it very private. People may not even know you set it up or own it or manage it even. There's some techniques there. A few other states have the same benefit, but Wyoming's cheap, easy. They are kind of what Nevada used to be 20 years ago. They want to be the cool place to set up. So Wyoming entities have better protection, better cost, better privacy. So people think, oh, well, I'll set up in Wyoming. Even if I live in California or Missouri or wherever, I'll just do Wyoming because it's cheaper, easier, better. Well, it can be as a holding company for your other entities. And if I do set up in Wyoming, I've still got to register where else I'm doing business. There's some issues. It's not just a file a form, I'm done. Wyoming just solved all my problems. No, you're adding another layer so that we were level 2. You've got a lot of assets. You want this Wyoming entity to own those other LLCs. You're going to want better asset protection, maybe is why you would do that. It's not going to save you taxes because wherever you do business is where you pay tax. Oh, so there becomes kind of an awakening of why you have that Wyoming entity. And we may keep it. We don't want to empty the bathwater and let it go down the drain. Let's keep it. But maybe it doesn't need to go. And that's— yeah.

And it's that Wyoming entity is not providing you immediate benefit, zero tax saving. In fact, it's costing you money to keep it there, pay the annual fee, pay pay for a registered agent, pay for someone to help keep it up to date. I mean, so you gotta say, what's the benefit of it? It's an asset protection benefit that's somewhat nuanced, okay? It's something called inside— sorry, outside liability. If you have liability outside of your entity in your personal life and they want to go after your assets, it's giving your company's protection from liability you personally incur. It's a very short explanation of it, but basically I would say 9 out of 10 of our clients don't even do that. And these are clients making great money that have assets worth protecting. All right. So it's, it's gotten a little oversold. It's not that it's a bad strategy. It's just like been oversold.

Yeah. I mean, if I was in the kitchen, you know, I mean, those Bosch mixers look so cool.

Yeah. I thought you were going to go with like the, you know, the, the, the— what's the butcher's knife? Oh, you're trying to like, you know, just, just cut a tomato or something. Exactly.

Yeah, yeah, you know, but you know, like, it could be the Bosch, you know, you're at Target, you're like, man, my mom used to have one of those, those are cool. But you only make chocolate chip cookies twice a year, you never bake bread, and you go buy the Bosch mixer and it just collects dust and sits in the cupboard and you don't need it. Now, is it— could you use it?

Maybe.

Would it be super cool to have out there and tell everybody I got a Bosch mixer? Yeah, but You know, anyway, kind of oversold. Yeah.

Yeah.

Okay.

Now, Mark, we really tried there. Yeah, we tried. That was a stretch.

Okay, now let's summarize where we're at. You now know you've made a lot of headway in this podcast with us. You now know S corporations for operations, LLCs are for holding assets or defining a partnership. I want all that income to flow through an S corp when it's ordinary. I want— but if Matt and I are going to hold a rental property together, we'll have an LLC of that. With that partnership, but we're not going to have our S corps own it because again, it's an asset. So S corps are never going to own real assets. Okay, so now we're going to set up the entity in the right state. We might add extra layers if we've got more assets worth adding those layers. But then the last thing a lot of people don't realize is I got to maintain this. I just can't set this up and done. That little one sheet of paper is in the drawer. These LLCs and these LLCs taxed as S corps might have to file a tax return. They need to do annual minutes. They need to be updated with the state every year. So many states require an annual fee. They actually require you to go to the website and check a box or send something in physically, have it approved. So you've got all these little things that maintain it, and that's where the real asset protection is. It's not some Delaware crazy, you know, something constitutional trust, or I got to do an irrevocable trust or whatever.

It's the little things.

It's the base hits. That win the game. The base hits are just doing the annual meeting and taking a write-off to do it. I mean, there's a lot of cool benefits here of maintaining, but a lot of people don't realize you really don't have an entity if you're not doing the little things.

Yeah, yeah. And all that benefit of the setup can go away if you're not actually maintaining it. So let's make, let's make sure once because you now you're building, now you actually have something. Okay. Have you neglected your entity? You got to pay attention to it. So let me— I want to say one other thing. So I want to make sure someone who's brand new to this, understands an important distinction. We would explain operations and assets here and using an S corp or LLC taxed as an S corp for operations and just using an LLC that's flowing down to you as a sole proprietor right onto your 1040-K. There's no corporate election or anything. It's just what's sometimes called a single-member LLC. There's one— there's a key reason why, and I just want to make sure you say this. We've got way more on other podcasts. When you're making money from commissions, selling goods or services, you pay income tax and you also pay self-employment tax on that income. The S corporation is a strategy that saves and minimizes self-employment tax. That's why we use it. But it only matters for ordinary income. Again, selling goods, selling services, or commission income. If I have investment income, rental income, capital gain income, The type of stuff when I own a rental property or I sell the rental property for gain or my crypto or other investment portfolio, that income is never even subject to self-employment tax. There's no reason to run it through an S corporation and go through the, the stuff you have to go through with that. Instead, it flows right on to my 1040, zero self-employment tax, which, by the way, is 15.3%. But, but that's the reason here. There's that tax reason. There's asset protection reasons we're separating it to, but it's that fundamental tax reason. So think of those things. And sometimes the why behind it can help you connect this.

Yeah, great, great, great point. Okay. And before we give you a resource here to help you get this done affordably and bring it all together, because you may have all the pieces and parts, we just got to bring it together. We're going to bake that cake. All right, man, we're killing this. Okay. Last thing before we give you a resource here. Who owns all this? And that's kind of that missing link too, that a lot of people are like, okay, that makes sense, but Who owns these entities and who's on title and all that? Like, bring it together. It's so freaking easy. You're going to love this. At the end of the day, in this trifecta, at the bottom of these two sides is your revocable living trust. And I am more and more adamant every year I practice as a lawyer to just say, get it done. A will is not going to cut it. It's not worth the headache of going through probate and all that mess. A revocable living trust is for you if you're young or old, male or female, kids or no kids, married or single, does not matter, rich or poor. And it can be affordable. It is affordable. And it becomes the owner of all this to keep it maybe more private and just to keep it simple. You're organized. Organized people make more money. Organized people sleep better. Organized people are more successful. You can be organized so that trust at the bottom We'll bring the whole thing together. You can add it later. You can start with it. You can, you may even have it in the mix, but it's not on ownership of these entities. And also with the assets. And just to give an example, the LLC owns the rental property. Even if you closed in your name because the bank wanted you to, you're going to deed it after. I don't care if it's a VA loan or whatever loan. There's no due-on-sale clause. The banks understand you're going to put it in an LLC if it's a rental. The LLC is owned by the trust. Boom, bada-bang, top to bottom. Property owned by the LLC, LLC owned by the trust. Over on the left side, you got your S corp LLC doing business, owned by the trust. They, like Matt said, we're not across the river, brother, sister, but with the same owner at the end of the day, not through the center.

Yeah. So let me give One thing here, just because I know we've talked about a lot, and the first thing I want to say as we're closing this is you don't have to master this. You don't need to know anything except the right person to call to get it done. It's just like someone who's trying to sell their house and doesn't know what the heck they're doing. They don't know how to price it. They don't know what to disclose. They don't know the documents. They don't know how you're going to attract buyers. They have no idea what they're doing and they're going to go for sale by owner. Are you going for sale by owner when you're doing your tax and legal planning because you think you're smart and you got a computer and Google and maybe some ChatGPT giving you some answers? We've seen the train wreck of that. All right. So we have a whole set— we have a whole system and a service called Cleanups where we fix people's DIY stuff. So just get engaged with us or some attorney or licensed professional, an attorney or CPA that can structure this property. We do it every day for clients across the country at a reasonable fee. We'll diagram it, make it visual so you can know how to put it into practice so that your accountant will understand it, so that your insurance agent, your, your advisor or anyone else that gets into your world will understand how this is all structured. You being first and foremost. So that, but what, what happens at the end here? Okay. We've got this problem of confusion. We don't know what we have. We don't know if it's optimized properly. The solution is letting us help you get there to figure it out for your specific situation. We do this every day. And at the end of the day, you can have confidence that you're not overpaying in taxes, that you don't have stuff you don't need. Too many— sometimes just clients need to shut stuff down. They have too many days not even helping them, but also that you've maximized asset protection. Then your brain, this 2% in your brain that's sometimes focused on all this crap I need to get to, is gone. You can focus on yourself, make more money.

You know, full circle, this woman that I was talking to that kind of got my juices flowing here, why I wanted to bring this up today with Matt, is She was like, okay, where do I sign up? How do I do this? And so right down the hall we had Chantel and our KKOS team. They got her into a consult for under $2,000. She's getting a comprehensive consult with a trifecta plan. And she was like, this is awesome. And when we just started to add up the operational efficiency of getting wrong, getting rid of the wrong entity, paying fees in a state that we didn't need and the efficiency of twisting this around and that, we had— we paid for that whole consult in the first year just by getting more efficient. And we didn't even get to the tax savings and the peace of mind. And so it really is helping unlock your potential when you get organized like this. You cannot put, you know, get biblical, you can't put old— new wine in an old bottle. You know, it'll break. And so let's get, let's get organized. You know, if I need to quote Kevin Costner in Field of Dreams, I will. You know, if you— if they build it, they'll come. Yeah. Yeah. So I did it, you know, I had to bring it.

All right, well, click the link. We have a link below. Get to kkoslawyers.com. That is our law firm with attorneys and a team trained by us. We've been working for clients across the country for years. Be happy to help you get you set straight. Thank you for everyone for tuning in to the Main Street Business Podcast. If this helped you, give us a thumbs up, a 5-star, share it with your friends and family. We'll see you next time.