April 28, 2026
Last Updated : April 30, 2026
S corporations are one of the most misunderstood entity structures in real estate investing. While they can be effective in the right situations, they are often misapplied to rental real estate, creating significant tax issues down the line.
In this episode, Thomas Castelli and Nate Sosa break down why S corporations and rental properties don’t mix, what happens when investors get stuck in this structure, and whether there’s any way to fix it.
Many investors find themselves holding rental properties in an S corporation due to poor advice or a misunderstanding of tax strategy.
A common belief is that S corporations help reduce taxes by avoiding self-employment tax. While that’s true for active businesses, it does not apply to rental real estate.
Rental income is generally not subject to self-employment tax in the first place, so the primary benefit of an S corporation doesn’t exist here.
S corporations are designed for active income, not passive investments.
They can be useful for:
In these cases, income is subject to self-employment tax, and an S corporation can help reduce that burden.
For rental properties, however, this advantage is irrelevant.
One of the biggest misconceptions is that an S corporation provides legal protection.
It does not.
An S corporation is simply a tax election, not a legal entity. You can have an LLC taxed as an S corporation, but the S election itself does nothing to enhance liability protection.
This confusion often leads investors to choose the wrong structure entirely.
A helpful way to think about entity selection:
S corporations limit your ability to increase basis through debt.
In a partnership, both your invested capital and your share of debt increase your basis. In an S corporation, only the money you personally contribute counts.
This can restrict:
Over time, this limitation can create real tax inefficiencies.
The most significant issue arises when you need to restructure.
If you try to remove a property from an S corporation, the IRS treats it as if you sold the property at fair market value — even if no sale actually occurred.
That means:
This is often referred to as “phantom income,” and it’s the core reason S corporations are so problematic for long-term real estate investors.
As properties appreciate, the problem compounds.
An investor who purchased a property for $500,000 that is now worth $3.5 million would face a $3 million taxable gain simply for moving the property out of the S corporation.
This creates a situation in which restructuring for financing, asset protection, or estate planning becomes extremely costly or impossible.
The short answer is no.
Common strategies investors look into include:
However, none of these eliminates the core issue. The gain is still recognized, and the tax is still due.
There is no clean, tax-free exit once a property has appreciated inside an S corporation.
While there’s no perfect solution, there are a few paths investors can consider:
Selling to a third party allows you to at least generate cash to cover the tax liability.
Some investors choose to hold the property indefinitely and address the issue through estate planning.
This can spread the tax burden over time, but doesn’t eliminate it.
In some cases, losses from other strategies may help reduce the tax impact.
If the property was recently placed into the S corporation and hasn’t appreciated much, removing it sooner may result in minimal tax consequences.
The most effective solution is simple: don’t put rental properties into an S corporation in the first place.
Instead, consider:
A straightforward structure that is disregarded for tax purposes and provides flexibility.
Offers the greatest flexibility, including:
These structures are far more appropriate for rental real estate.
There are limited situations where an S corporation can make sense:
These activities involve active income, which aligns with the benefits of an S corporation.
For buy-and-hold rental properties, they are almost always the wrong choice.
A common question is whether there’s a specific number of properties required to qualify for Real Estate Professional Status.
There isn’t.
It is technically possible to qualify with one property, but only under very specific circumstances where the investor is heavily involved.
In practice, most investors will need:
The determining factor is not the number of properties, but the amount of work involved.
S corporations are a powerful tool when used correctly, but they are often misapplied in real estate investing.
Once a rental property is placed in an S corporation and begins to appreciate, it becomes extremely difficult to restructure without triggering significant tax consequences.
The best approach is to set up the right entity structure from the beginning and avoid the problem entirely.
For investors who are already in this situation, the focus should shift to minimizing damage and planning the best possible exit strategy given the constraints.
Schedule a discovery call to learn how we can help you reduce your tax liability and create a plan tailored to your goals.
Disclaimer: This podcast summary was generated from the transcript and may contain some errors or miss key points from the audio recording.
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