The Best Business Structure for Real Estate Investors
If you are considering turning your real estate investment projects into a business, you will need to give serious consideration to what type of business you want it to be.
The right solution depends on your specific situation, but a few key questions to ask yourself are:
- How will I structure my real estate investment company?
- How many people will own the business?
- What are my concerns for liability?
- How much do I care about tax benefits?
- How much effort do I want to put into creating an overarching business entity?
Read on to learn the different types of business structures you should consider, and the pros and cons of each type of business structure.
Types of Business Structures for Real Estate Investing
Starting a Real Estate Investment Sole Proprietorship
There are many ways to structure your real estate investing business. Sole proprietorship is the most simple business structure in which you can operate a real estate investment business. It is not a legal entity, and all the owner of the business is personally responsible for its debts. You can choose to do rehabs as a sole proprietorship in your name, or a "trading as" name, without creating a new legal entity. While this is the easiest and least expensive way to become a real estate investor, there are many disadvantages.
One major disadvantage is that many real estate investment lenders will not lend to an individual because of legal restrictions in some states that require loans only be made to a business entity. Another reason that real estate investment lenders may not lend to a sole proprietorship is that the lender wants to avoid any possibility for the loan to be viewed as a consumer loan. As a whole, private lenders generally have a blanket prohibition on loans to individuals.
Doing business as a sole proprietor also exposes you to greater liability in an event of an accident at the site and greater financial exposure.
Lastly, there are less tax benefits when doing business under your own name than there are as doing business as a legal entity. Choosing to move forward under your own name may be the easiest, but not necessarily the safest or least expensive way to proceed.
Starting a Real Estate Investment LLC or LP
Two other common business entities for real estate investors is the limited liability company (LLC) or limited partnership (LP).
The LLC can be formed by either an individual (a single member LLC) or multiple people (a partnership type LLC or LP).
The LP, by definition, requires more than one person.
LLCs and LPs provide some legal protection to their individual owners as liability for accidents, finances, etc. lies with the LLC or the LP (with some limitations). Both LLCs and LPs can be structured to be "pass-through" entities for tax purposes. What does this mean? A pass-through structured entity means there is no taxation to the business - all income, deductions, etc. are passed to the individual partners.
It should be noted that not all members of an LP are shielded from liability. In most cases, LPs have both a general partner and limited partners. The limited partners can invest in the business and share profits and losses, but they do not actively engage in the management of the business itself. The general partner is responsible for all management but remains liable for the obligations of the LP.
Starting a Real Estate Investment Corporation
Lastly, some real estate investors form corporations. While a corporation provides the greatest protections to the owners, they are also the most expensive and cumbersome to form and maintain. They are also generally taxed on their own, rather than "pass thru" income to the owner.
Seek Advice from Professionals
You should seek the advice of an attorney and accountant to determine the best real estate business structure for you.
An attorney will lay out your options, and outline the legal benefits and disadvantages of each type of business structure.
An accountant will advise you of tax advantages and requirements of different types of business structures, including sole proprietorships, limited partnerships, limited liability companies, and corporations.
This will help you decide which structure is best for you. They will also assist you in tracking your business expenses and, of course, in preparing tax statements as due for your particular type of business.
Great consideration and thought should be given to forming the right business entity for your real estate investment business. If you have followed RFG's advice and created a business plan, the choice of structure should be clearly outlined in the plan, with an explanation of the appropriateness of the structure for your business.
It cannot be over emphasized that this is part of the planning process for your business and should be done with care, careful deliberation and with the advice of experts.
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