When should I convert my LLC to an S corporation?
When your fee or service income — management fees, acquisition fees, property management revenue — reliably nets somewhere around $60,000 to $80,000 a year, depending on your state. Below that, payroll and compliance costs eat the savings. Above it, the self-employment tax savings compound. But the election belongs only on service income: an S corp must never hold your real estate ownership interests.
What the election actually does
An LLC with one owner is disregarded by default. Its income lands on your Schedule C and every dollar of net profit is subject to self-employment tax at 15.3% — 12.4% Social Security up to the wage base ($184,500 in 2026) plus 2.9% Medicare with no ceiling, and an additional 0.9% Medicare surtax above $250,000 for joint filers.
Elect S corporation treatment and the income splits in two. You pay yourself a reasonable salary, which carries payroll tax. The remaining profit is distributed to you as a shareholder, and distributions are not subject to self-employment tax.
That is the entire mechanism. It is not a rate reduction; it is a reclassification of part of your income out of the payroll tax base.
The math, and where the threshold comes from
Assume a management company netting $150,000, with $70,000 established as a reasonable salary.
| Disregarded LLC | S corporation | |
|---|---|---|
| Net profit | $150,000 | $150,000 |
| Subject to SE / payroll tax | $150,000 | $70,000 |
| Distribution not subject to SE tax | — | $80,000 |
| Approximate SE / payroll tax | ~$21,200 | ~$10,700 |
| Approximate annual saving | — | ~$10,500 |
Illustrative only. Actual figures depend on your salary determination, state, and the deduction for one-half of self-employment tax.
Now run it at $60,000 of net profit with a $40,000 salary. The saving is roughly $3,000 — against payroll service fees, a separate 1120-S return, state franchise or minimum taxes, and more bookkeeping. In a high-fee state the two numbers roughly cancel.
That is where the $60,000–$80,000 rule of thumb comes from. It is not in the code; it is where the arithmetic turns positive.
Reasonable compensation is the whole risk
The election's benefit scales with how much profit you can treat as distribution rather than salary — which creates an obvious temptation, and the IRS is well aware of it.
Compensation must be reasonable for the services actually performed. Set it too low and an examiner can recharacterize distributions as wages, with back payroll taxes, interest and penalties. There is no safe-harbor percentage, despite what you will read; the standard is what you would have to pay someone else to do your job.
Defensible positions are built from evidence: comparable market salaries for the role, hours worked, the mix of your time between services and passive oversight, and how much of the profit is attributable to your labor versus to capital. Document the analysis when you set the number, not when you are asked about it.
One warning specific to real estate. Salary is non-business income for §461(l) purposes. Paying yourself a large salary out of an operating business, while also generating heavy depreciation, can convert shelterable business income into capped W-2 income and disallow deductions you were counting on. Your reasonable compensation figure and your depreciation plan are one decision, not two.
Read more: Why is my real estate depreciation write-off capped at $512,000?
What belongs in the S corp — and what must not
This is the part that matters most for fund managers, and getting it backwards is expensive.
| Put in the S corp | Never put in the S corp |
|---|---|
| Asset management fees | GP / carried interest |
| Acquisition and disposition fees | LP investments |
| Refinance fees | Direct real estate ownership |
| Construction management fees | Any leveraged partnership interest |
| Property management revenue | Appreciating assets you may move later |
Why ownership must stay out. Under §1366(d), S corporation shareholder basis is stock basis plus direct shareholder loans. Corporate-level debt — including debt at a lower-tier partnership the S corp is a partner in — creates no shareholder basis.
Partnerships work the opposite way. Under §752, your share of entity liabilities increases your basis, and qualified non-recourse financing counts as at-risk under §465(b)(6). That is what makes leveraged depreciation usable.
Put an ownership interest inside an S corp and the debt basis never reaches you. A $1,000,000 depreciation allocation against $100,000 of stock basis produces a $900,000 suspended loss stranded at the corporate level.
And you can't easily undo it. Distributing an appreciated interest out of an S corporation is treated as a sale at fair market value under §311(b). The corporation recognizes gain, it passes through to you, and you pay tax to move an asset from one pocket to another. A promote that has grown in value is exactly the asset you would most want to move into a dynasty trust — and exactly the one an S corp locks in place.
Read more: Should I hold my GP interest in an S corporation?
The QBI interaction
Section 199A allows a deduction of up to 20% of qualified business income from pass-throughs, and OBBBA made it permanent. The S corp election affects it in two ways worth modeling.
W-2 wages can help. Above the income thresholds, the deduction is limited by a formula based on W-2 wages paid and the unadjusted basis of qualified property. An S corp paying wages may support a larger deduction than a sole proprietorship paying none.
But asset managers face the SSTB limitation. A "specified service trade or business" — broadly, one whose principal asset is the reputation or skill of its people — loses the deduction entirely above certain income levels. Many asset management and advisory companies fall into this category.
This is where deductions start stacking, and where planning earns its fee. An owner over the SSTB threshold gets no §199A benefit at all. Bring taxable income down with depreciation and other strategies, and the deduction can come back onto the table — which means a depreciation decision and a QBI outcome are linked in a way that is invisible unless someone models them together.
Beyond the tax saving
Two reasons to make the election that have nothing to do with payroll tax.
Enterprise value. A management company that survives deal to deal is a real business — recurring fee revenue, a client base, a track record. Larger sponsors buy platforms like that. Spinning up a new manager entity for every deal builds nothing; a permanent management company accumulates something saleable.
Bankability. Anyone who has tried to get a residential mortgage while holding fractional GP and LP interests knows the problem. A stable operating company paying you a W-2, with several years of returns behind it, makes you a legible borrower. Underwriters understand salary. They do not enjoy K-1s.
The decision, in order
- Is this fee income for services performed? If it is ownership income, stop — the answer is no regardless of the numbers.
- Does net profit reliably clear $60,000–$80,000? Reliably, not once.
- What is a defensible salary? If a reasonable salary consumes nearly all the profit, there is nothing to save.
- What does your state charge? Franchise taxes, minimum fees and separate state filings can erase the benefit in some states.
- How does it interact with QBI and §461(l)? Model these together, not separately.
Then elect — generally within two months and fifteen days of the start of the tax year you want it to apply to, though late-election relief exists.
Frequently asked questions
At what income does an S corp election make sense?
Generally when net profit from services reliably reaches $60,000 to $80,000 per year, depending on your state. Below that, payroll processing, a separate 1120-S return and state fees typically consume the self-employment tax savings.
How much does an S corp save on self-employment tax?
It depends on the split between salary and distribution. On $150,000 of net profit with a $70,000 reasonable salary, the saving is roughly $10,000 per year. Only the distribution portion escapes self-employment tax; the salary remains fully subject to payroll tax.
Should my real estate LLC be an S corporation?
Almost never, if it holds property or partnership interests. An S corporation blocks entity debt from creating shareholder basis under §1366(d), which strands depreciation. Use an S corp for fee and management income only.
What is reasonable compensation for an S corp owner?
What you would have to pay someone else to perform your role, supported by market salary data, hours worked, and the split between service and capital in generating profit. There is no statutory safe-harbor percentage, and setting salary too low invites recharacterization with penalties.
Can I move assets out of an S corporation later?
Only at a cost. Distributing appreciated property out of an S corporation is treated as a sale at fair market value under §311(b), triggering gain that passes through to shareholders. This is a key reason not to place appreciating ownership interests inside one.
Does an S corp election affect my QBI deduction?
Yes, in both directions. W-2 wages paid by the S corp can support a larger deduction above the income thresholds, but specified service trades or businesses — which many asset management companies are — lose the deduction entirely above certain income levels.
One decision, three interacting consequences
Salary level, depreciation capacity and QBI eligibility all move together. Model them separately and you will optimize one while breaking another — which is the most common pattern we see on returns prepared by someone looking only at the entity in front of them.
Stonehan offers a free 15-minute consultation. Bring your entity chart and last return, and James will tell you whether the election is worth making, what salary is defensible, and what it does to everything else.
Book a free 15-minute consultation →
James Bohan, CPA · Founder, Stonehan Accountancy, P.C. · Coeur d'Alene, Idaho · CPA since 2011 · MRED, University of Southern California · Fourth-generation real estate developer
This article is educational content and is not tax advice. Tax advice requires a review of your specific facts and circumstances by a qualified professional. Illustrative calculations are simplified and will differ from your situation.
