Here is a summary of my articles on Entity Structuring for real estate investors, plus some typical questions I get asked on a daily basis on my blog from real estate investors.
THE TAX SIDE OF ENTITY STRUCTURING
There are three main aspects of entity structuring: legal, tax and compliance. The goal is to find one that meets all three criteria. One size does not fit all. Structures can be changed.
1. Ease of compliance – What are the compliance requirements? – annual filings, fees, separate tax returns, mandatory meetings, etc.
2. Tax Liability Reduction – What is my tax exposure based on my real estate or business strategy and how can a specific entity reduce that tax liability?
3. Asset Protection – How does this entity protect me from Bottom up and Top down creditors?
There are different entities that are appropriate for different types of real estate investing. Before we look at the difference, here’s an explanation of why it is necessary for every business to incorporate.
Advantages of Incorporation
Protect yourself from liability – The most important reason to incorporate your business is to protect yourself from business liabilities.
Establish perpetual existence – Perpetual existence means that the life and continuation of the business will not be affected by the withdrawal or death of one of the owners.
Gain tax advantages – There are tax deductions for a wide variety of operating costs which will substantially cut back your company’s overall tax liability.
Enhance business image – Another essential reason to incorporate your business is that it adds credibility to its operation. The perception of a business is improved by its incorporation and use of “Inc.,” “Co.,” or “LLC” following the name of the business.
Improve Management Ability- The authority of an incorporated business is centralized, which usually means a Board of Directors.
Ease of Incorporating – Incorporating does not take time and can cost you less if you do not use a lawyer.
THE LEGAL SIDE OF ENTITY STRUCTURING
When choosing an entity for your real estate investment, it is vital that you understand the legal issues involved, so you can protect your assets. We have already explored the tax implications of entity structuring. Here we will look in depth at the LEGAL side of entity structuring, Land Trusts as well as LLC transfer tax issues.
Bottom Up Creditors & Top Down Creditors
With the legal side of entity structuring, you need to ensure that you have an entity that shields you, does not leave your personal assets totally exposed and protects you from legal actions. It is not the size of the entity, but rather the existence of complete and proper documents, which provides the protection from personal liability for the LLC members.
A water-tight entity also protects you and your business from BOTTOM UP CREDITORS (has a claim and/or gets a judgment against the LLC arising from the acts or omissions of the company rather than from the acts or omissions of a member, manager or employee) as well as TOP DOWN CREDITORS (gets a judgment against the member because of the member’s acts or omissions, rather than the acts or omissions of the LLC, its managers or employees).
Multi-member LLCs can help protect your assets. With a good operating agreement and an umbrella insurance policy, you can minimize (NOT MITIGATE) your exposure.
1. LIMITED LIABILITY COMPANIES (LLC’S): The legal rights of members are governed by state LLC statutes (like corporations), but LLC laws vary from state to state.
2. PARTNERSHIPS: In a partnership, each partner is jointly liable for all partnership debts. These are inexpensive and simple to form. General partnerships are not recommended for real estate investments because of the liability exposure.
3. LLC-PARTNERSHIPS: In most cases the LLC-partnership will be the ideal entity preference for real estate ownership. The corporate structure of an LLC protects its owner-members and their personal assets.
4. LIMITED PARTNERSHIPS (LP’S): There is limited liability for the limited partners, but personal liability for the general partner.
5. CORPORATIONS: Corporations give its shareholders limited liability protection.
THE COMPLIANCE SIDE OF ENTITY STRUCTURING
Investors typically have lots of questions regarding the compliance side of entity structuring. There are many things to consider such as: states to register, tax filings and what a properly set up business looks like. In this article, we will examine all the different aspects of compliance when structuring an entity for your real estate investments.
Ease of Compliance
Where to incorporate
Choosing where to incorporate your entity is important, because the state of incorporation will be the company’s legal home. Most states don’t require a business to maintain an office within the state; a company can operate business in another state. The most common choices of states to incorporate are: state of operation, Delaware or Nevada.
The State Where You Operate – My Choice
Incorporating in the state of operation is the least complicated and least costly choice. In addition, if you were to get sued, the local laws will govern. So your entity should have a legal standing in the state where you intend to operate your business.
Delaware
Delaware is very popular as an incorporation state with thousands of start-up companies in the US. Delaware has low incorporation fees, low taxes and management flexibility making it an attractive option.
Nevada
Again, Nevada is attractive to new companies because of its favorable corporate laws such as: low taxes, low fees and corporate privacy laws. But, like Delaware it is larger corporations who have the most to gain from incorporating in Nevada. Similar to Delaware, smaller corporations may find more disadvantages than benefits to incorporating in Nevada.
Here are a couple of recent questions from my blog on Entity Structure and Compliance…
Question: “A client came to me and asked why he did not get any stocks from an LLC. I told him that LLC does not issue stocks. He told me that he once went to an attorney to set up a LLC. He keeps insisting that the attorney told him he would have such and such amount of stocks in that LLC. Am I missing something?”
My Answer: You are missing what is commonly called “Units of Membership”,”Units of Ownership”, or “Membership Certificates“. They look like shares of corporate stock and result in basically the same as shares of corporate stock. I have made them in the past for a client with my PC.
Question: “I have never heard of these certificates for LLCs. Is this unique for certain states or just window dressing for clients who want something on paper.”
My Answer: It is window dressing. Just like “stock certificates”. How many small corporations do you know of actually have a piece of paper that designates the number of shares they own?
Question: “I have just completed my real estate broker course and am waiting to take the state exam. I already setup an LLC a couple of years ago to buy and flip properties. If I do set up my own real estate brokerage office as opposed to working with a non-licensed partner, will it be ok to use my existing LLC to buy sell and broker properties, or do you recommend setting up a new separate LLC? Thanks in advance for your suggestions.”
My Answer:
This is ok to maintain history as long as you originally set up the LLC right by not using your home address or yourself as the resident agent. These are asset protection busters. You would only need to update your operating agreement for the new brokerage office.
I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan. You can get more information at Wealth Building Plan.
