deciding business structure for REI

deciding a business structure for REIWhat Business Structure Is Right For Me?

When you select the structure under which you will operate your real estate investing business, you are making a very important business decision.  The basic organizational structures available to real estate entrepreneurs today are partnerships, corporations and limited liability companies.

The most common question I get from students is whether they should form a LLC or a C Corporation and what are the advantages and disadvantages.  Here is a short overview to help you clarify which organizational structure or entity may best suit your situation.

Before we start it’s important that you understand that the choice of entity depends on your tax situation. It is not asset protection; rather it is the tax aspect that determines the choice because most of all entities will provide some asset protection.

Please note:  You should consult a professional attorney who has expertise in this area and talk to your CPA before making any decisions.  As you may guess, I’m not either. So let’s start…

The type of business organization you choose will depend on many factors including the nature of the business operation, legal restrictions, capital needs, tax advantages, how you divide your earnings, number of owners, the life expectancy of the business, and whether you need to protect personal assets from the business assets.

The general corporation is the most formal business structure available to business owners.  It is a legal entity in its own right, separate from its owners that is owned by an unlimited number of stockholders.  In most cases, you’re alone, or you and your spouse will be the only stockholder(s) when it comes to your real estate investment corporation.

In general, the corporation owners’ personal assets are protected from business creditors due to the legal separation of the corporations from the owners.  Stock holders do not have liability for acts of the corporation and have financial exposure only limited to their investment in the company.  This is not to say that as an owner of a company you don’t have any liability to your acts of neglect or blatant wrong doing.

The advantages of a general corporation is that the owners’ personal assets are protected from business debt.  Also, the corporation has unlimited life that extends beyond the illness or death of its owners.  A corporation receives tax free benefits such as life and health insurance, travel and entertainment deductions and retirement plans.  Other advantages are that transfer of ownership is easily facilitated through the sale of stock, and change of ownership can occur without affecting management. Now, keep in mind, we also use Land Trusts as title holding devices where the transfer of property ownership is a lot more convenient than i.e. selling stocks of a corporation owning the property.

Some of the disadvantages of general corporations are that corporations are more expensive to form than most other forms or types of business.  Also, there is more legal formality and record keeping required than with a simple LLC.  Finally, there are more federal, state and local rules and regulations that affect the corporation.

Like general corporations, LLCs offer their owners protected personal liability from lawsuits and judgments against the business.  Unlike general corporations which have an unlimited lifespan, LLCs must set a predefined duration to keep the pass through tax advantage.  The LLC is a flow through entity and therefore business income or losses are only reported on the member’s individual income tax return (unless you elect a different tax status).  In addition, many LLCs operate informally with little paperwork beyond the Operating Agreement or contract that describes the company’s policies and organizational structure.  I also want to mention that the managers of a LLC do not have to own any interest in the LLC and LLCs are not required to change anything upon the death or bankruptcy of a member.

It is also important to remember that any owner of interest in a LLC can sell their interest without limitation or be subject to a right of first refusal by the other members.  Finally, LLCs do not face double taxation like corporations but instead profit and losses are passed through directly to the owners of the limited liability company.

For real estate, it is best to setup a C corporation for the properties you keep less than 12 months (i.e. you buy, fix and flip).   This will help you avoid the dealer status as an individual and by definition a C corporation is a dealer.  For property you want to buy and hold for over 12 months, I suggest a “single member” LLC to hold the assets (rental and lease options).

During our live training, I always find time to cover this necessary topic and draw a simple diagram of how I hold my properties and which entities I use to own them, to manage them and also for short term deals.  When you get to own a lot of properties, it is always a good idea to not put “all your eggs in one basket” by using multiple LLCs.

And before I end, I must stress… you do NOT need many different entities and complicated structures before you start! In fact, you may never need them and most investors get sold into overdoing this part of their business (including myself). Keep it simple and start. Remember, you can’t deduct the loses or the cost of doing business, or cost of education if you have no profit – so getting your first deal is the key here!

You can even form your first entity yourself, and start doing deals. Then, you need to get a competent attorney and your CPA to look over it and suggest the best way to maximize the tax savings.

Be safe, be decisive, and make a lot of money!

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