Structuring Your Business for Success!

One of the first things to consider when you are starting your real estate business is how you are going structure your business or businesses. I probably would say in most cases the word businesses! Over the years of dealing with my business, working with clients and the people whom I do business with, I have learned a great deal regarding the ways of structuring entities for success. I have seen the affect of poor planning which include increased risk, personal liability, and a servicing and filing nightmare at great cost. The one thing I would like to make clear is that this is business advice and not legal or tax advice. When you start your business you should consult with a CPA, attorney and others investors or business owners that operate the type of business you are setting up. A good mentor can be worth their weight in gold as you start real estate business and structure it for success.

The five basic entities for business are: Sole Proprietorship, General Partnership, Limited Partnership, Corporation and Limited Liability Company. Choosing the entity usually depends on issues and concerns with people, place and things.

The People Factor plays into ownership and how you limit risk, liabilities, hold personal guaranty for the business operations to the business owner(s) and or partner(s) for the business. Also how you bring people into and out of the business as owners vs. investor. These are all major consideration when choose the entity for your business.

The Place Factor for Real Estate investments is the property ownership and is commonly considered a holding company.  The holding company should have no employees, products or services involved with it, just real property ownership. In highest and best use cases hold companies are just a pass thru entity for the income that the property(s) produce to the owner(s) of the holding company.  

The Things Factor for entities are employees, providing services and products such as Management, Rehabbing, Financing and more. It is important to keep the liabilities of your employees’ services and products separate from your holding company liabilities.

My choice for success for holding companies are Limited Liability Companies.

The Limited Liability Company (LLC) is a business entity organized under state law and regulations that offers limited liability like a corporation along with the possibility of “pass-through” taxation, unless it elects corporate treatment for federal tax purposes. Therefore, an LLC is a cross between a partnership and a corporation.

An LLC is owned by one or more interest holders called “members”.  A member or members can exercise management rights over their LLC. However, an LLC also allows the members to designate specific managers who may or may not be members, to manage the entity as is done in many corporations. Like a corporation, an LLC has the advantage of “perpetual” existence — its business operations can continue despite the death of someone who owns a business interest. Ownership interests are transferred easily from one member to another or to an outside party wishing an ownership interest in the LLC.

Liability under a LLC provides limited liability for its owners similar to shareholders in a corporation. The LLC owner risks only their investment in the business. Other personal assets are not at risk, unless the owner has personally guaranteed debt for the LLC. In those cases the owner could be held liable up to the debt guarantee but is not exposed to operational liabilities above the LLC assets.

Tax liabilities for LLC under IRS regulations allow for LLC with more than one member to be taxed as a partnership unless it elects to be taxed as a corporation. If it is treated as a partnership, the LLC’s earnings will be apportioned to its owners and taxed at their personal tax rates, similar to the tax treatment of a limited partnership. However, it is possible to elect corporate tax treatment, whereby it will be taxed as a corporation, not something that most people would choose. An LLC with only one member can be treated as a disregarded entity for tax purposes and will flow straight over to the single member’s personal tax return and taxed at their personal tax rate. The LLC allows for its member to avoid the double-taxation of corporations and ease of filing of personal tax returns. LLC’s are clearly the simplest entity to choose from for real estate holding companies.

Administration set up and record keeping required for LLC’s are easy to manage for the protection they provide. An LLC has an “operating agreement” which, like the agreement of partnership or LP, determines the conduct of the business, including the rights and powers of its members, managers, and employees and which generally allows the members to structure the company’s affairs as they see fit, rather than as a statute requires for corporations. One thing to remember about LLC’s is the fact that they are state regulated and should only be set up and used in states in which they do business in. Georgia has created some of the most owner and business friendly LLC protection and record keeping requirements in the United States. The sole reason is to attract businesses and investment to this state. You as a real estate investor should take full advantage of that fact for your holding companies.

When choosing the right type of entity for your real estate holdings, it has become clear to me and many other real estate investors that LLC’s are simply the best choice. They provide good protection against liabilities, ease of tax filings, and administrative ease along with personal tax rate options.  A little upfront planning will insure your long term success as a real estate investor. As always I wish you the best in all you do.