Why should I Incorporate my short-term Rental? What are the major types of corporations? What are each corporations’ pros & cons? How do I incorporate my short-term rental (Airbnb Rental)?
If you’re planning to have short term rentals, you may be asking yourself the same or similar questions. You may also be asking if it is worth establishing a formal company for your Airbnb rental. It can become overwhelming. Especially, when it comes to liability and taxes.
I took a deep dive into a lot of these questions and sought out answers. Anyone who follows this blog knows of my short-term goal of acquiring real estate in 2021. If you are new to my website, welcome! I document my journey through everyday financial life with posts, and monthly net worth updates. Additionally, I share information I learn through the process of increasing my net worth. Not only, will this post will discuss how I will manage my short-term rental company, but why I plan to create a business to own and manage it.
Why Should I Incorporate my Rental?
First, let me dive into the most obvious question. Why should I incorporate my rental? There are two main reasons individuals would do this.
1. Reduce the Risk
My main reason is to reduce the amount of risk I expose myself to. My accountant strongly recommended a business be setup to manage and own the property. Especially, since this will be a long-term business. Similarly to my other investments, this asset will be held long term. Additionally, the business will hold the liabilities of the property. In other words, the business will carry the distress of any potential lawsuits from other's mishaps at the short-term rental property. The Airbnb business will act as a legal protective barrier from claims filed. This would protect my other investments, assets, and personal belongings from being taken if a lawsuit had a negative outcome. It is my understanding, that if I am the owner of the property while the LLC only runs the business there is a potential for the liability to still be tied to me.
If the property is owned by myself, and not the company it would be considered a sole proprietorship. As such, the business is not legally separated from an owner. A sole proprietorship is not a legal entity. I do not believe renting out your personal property (rental is owned by you, not a business) is a complete risk issue. In fact, it is probably a decent starting point for the corporation to form. Additional insurance coverage is a way to manage the risk of personally owning the rental.
2. Manage Taxable Income
The second reason I want to incorporate my Airbnb rental is to manage the taxes that come with the income. There are numerous ways of managing the taxes when you have a business. Obviously, each business structure dictates how the business is taxed.
The next section will discuss each corporation's structure in detail and how they are taxed.
What are the major types of corporations?
There are five major types of corporations. They are designated as C corporations, S Corporations, Limited Liability Companies (LLC), Partnerships, and Sole Proprietorships. I will discuss about each of these. It should be noted, that I am not a lawyer or an accountant. This is information I have researched through the IRS website. Additionally, some content was provided from my accountant. Subsequently, each individual's situation is unique. As such, they should search out guidance for their own situations.
1. C Corporations
C corporations are any corporations taxed disjointedly from its owners. In fact, an owner will be taxed twice if they are a shareholder of a c corporation A C corporation files a return with the IRS. This is filing is in addition to the owner(s) tax filing. Shareholders of C corporations also pay taxes when they receive distributions from the corporations. Those distributions can include salaries and bonuses, dividends, and fringe benefits.
Ouch! Taxed twice? No thanks! Although, there are some exceptions. For example, distributions made in the form of additional stock rather than as dividends are typically not taxed.
Most major companies and numerous smaller companies are treated as C corporations. A C corporation has no limit on the number of shareholders, foreign or domestic. However, companies with more than 100 shareholders are typically C Corporations. This is because S Corporations cannot have more than 100 shareholders. Obviously, C Corporations are not the appropriate structure for my small rental business. C corporations are not a good business model for my short term rental.
2. S Corporations
S corporations are any corporations that pass corporate income, losses, deductions, and credit to the shareholder(s). In other words, the business is not taxed. Only the individual is taxed on the income or losses. This is known as a pass-through entity. Contrary to C corporations, S corporations are structure to avoid double taxation. However, it is important to understand each state’s tax law for S Corporations.
Additionally, the IRS has requirements for a business to qualify for S corporation status. Some of the requirements are as followed:
- Be a domestic corporation
- Have no more than 100 shareholders
- Have only one class of stock
The IRS has provided further requirements, instructions, and forms on their website. S corporations are a good business model for short-term rental businesses.
3. Limited Liability Company – LLC
A limited liability company, or LLC, is a business that does not have the legal status of a person. It does have individual(s) who are considered owners. Typically, start-up costs are lower than corporations. Limited Liability Companies (LLC) can have one or more owners. Similar to S corporations, LLC's are taxed as pass-through entities. Contrary, LLC tax filings are more simplified than S corporations. Additionally, LLC's can be taxed in four different ways. It can be taxed as a sole proprietorship, as a partnership, as a C corporation or as an S corporation.
As previously mentioned, my short term rental business will not be modeled as a sole proprietorship or C corporation. S corporations come with complicated tax filings. Additionally, an LLC taxed as an S corp lowers taxable income. This is due to the owner paying himself or herself a modest salary. The owner is treating themselves as an employee of the business. All remaining income will then be treated as dividends. Dividends are taxed at a lesser rate than the salary.
Partnerships are businesses that are owned by two or more individuals. Unfortunately, each partner would be personally liable for all debts and obligations incurred. In other words, each partner is responsible for the others decisions and obligations.
An agreement is usually signed by all partners. There are instances where one partner can legally bind other partners without their approval. I do not believe this is a good business structure for my Airbnb rental.
5. Sole Proprietorship
A sole proprietorship is a company that is owned by a single individual only. A sole proprietorship is an unincorporated company. This business structure does not separate the owner’s personal assets from the company. Therefore, the owner is fully liable for the its assets and liabilities. There is virtually no legal barrier or protection for the owner. The company is considered the owner’s personal income and therefore taxed as such. I desire my business to assist in risk reduction. Consequently, this business structure is not a good fit for my situation.
How Do I Incorporate my Airbnb?
I have used websites such as LegalZoom to incorporate companies. My experience with setting up businesses has ranged from $200 to $1,500. There are filing fees you will need to pay, as well as extra fees to obtain an employer identification number (EIN). It seems that the LLC's I have established required state fees as well. It is important to do research on the costs associated prior to developing the business. Consideration for out of state properties should also be evaluated.
Filing taxes for the business can be complicated. This is especially true when filing corporations over LLC's. Costs associated with tax filings should be reviewed prior to forming a company.
There are numerous ways to develop a business for your Airbnb property(s). Each individual’s situation varies. Unfortunately, there is not a simple answer to which tax classification to pick for your business. All the more reason to discuss your situation with an accountant or business attorney to help you choose your business entity. I plan on starting the property out without a company owning it. After equity and cash flow increase, I will form the LLC taxed as an S corporation to own and manage it.
Great additional resources:
Small Business Administration’s
10 steps to start your business: This website allows you to find information on doing business in each state. It is a resource for taxation, links for employers, and more.
Fund your business: It costs money to start a business, which may need more than your personal funding. The website link provides ideas for funding your business, which will may lead to the business structure.
Write your Business Plan: The website discusses the two common categories of a business plan, which is a traditional or a lean startup. It offers business plan examples to help guide your written plan.