Should I form an LLC or Corporation?
I’ve seen a recent trend amongst consultations of people who invest in real estate that they own in their name alone and this can be very dangerous from a liability perspective.
To help these clients, I typically discuss at least 5 forms of owning a real estate investment business. There are a few more that are highly complex and I would recommend you consult with an attorney and CPA. Basically, real estate is owned as a:
Sole proprietorship: A sole proprietorship is when you own a business (in this case a real estate investment business) in your name personally. I am unable to envision a situation where owning investment property in your name individually would be a good idea. You have greater liability to lawsuits, which can then open up other assets to liability – for example, someone could go after money you have invested in stocks if the successfully sue you for your ownership of investment property as a landlord. Or if you own multiple properties in your name individually, all of those properties are at risk if you get sued for an issue with one of them. Many of the tax advantages you could get for owning investment real estate will be unavailable if you own the investment in your name individually.
Partnership: In a general partnership, all partners are jointly and severally liable for the debts of other partners, and all partners have the ability to bind the partnership. Therefore, before you enter into a partnership you need to carefully vet your partner(s) to ensure: (1) they have no history of bad deals which could then bind you to their mistakes in future deals, and (2) are honest and are going to consult with you on decisions that could create liability (like buying, selling or mortgaging property).
Corporation (Corp, Inc.): A corporation is a separate legal entity created under state law. The corporation provides a number of liability advantages and, because the corporation is a creature of statute and contract, they are very flexible to fit your needs. The activities of the corporation are governed by written documents (and statute when the written document is silent) and the corporation limits or eliminates the personal liability of any shareholder or stockholder. Some drawbacks of the corporation are that the stock or shares of the corporation can be seized by creditors, but only the stock of the individually-liable shareholder (although the governing documents of the corporation can address this). Further, the C-Corporation has double-taxation – income is taxed when earned by the corporation, and then the shareholder is taxed when they take a distribution from the corporation.
Limited Liability Company (LLC): A limited liability company, like a corporation, is a legal entity created under state law. However, an LLC is more flexible than a corporation – limiting the liability of the owner to her investment in the company. The ownership interest of an individual owner is protected from seizure for the debts of a co-owner in a multi-member / multi-owner LLC (called a charging order, or a garnishment on distributions to that owner / member). The LLC is also a pass-through or disregarded entity for tax purposes, meaning the LLC is taxed as if the individual earned the money if the LLC has one owner, or the LLC is taxed like a partnership if the LLC has two or more owners.
Corporations can elect S-status, which means they will be taxed like an LLC. In addition, the LLC can elect to be taxed like an S-Corporation, which provides some great liability protection and tax advantages to the owner(s). Check with your CPA on the benefits of your LLC being taxed like an S-Corp.
Land Trust: Land Trusts are trusts, created under state law. The trust breaks the interest in the property between the legal ownership (the trustee) and the equitable or beneficial ownership (the beneficiary). Under many state laws that recognize land trusts, the beneficial interest is converted from real property (land, houses) to personal property, and the identity of the beneficiary is anonymous. The land trust structure gives the owner the ability to deal with the tenants as a property manager without revealing that she is also the owner – thus making the “owner” the bad guy on tough decisions like eviction, renewal, security deposit retention, negotiations, etc.
Some investors combine these strategies, setting up an LLC to be the trustee of a land trust that owns property, with a second LLC as beneficiary of the land trust. In this structure, the “owner” is anonymous and even if a court orders the trustee to reveal the owner’s identity, the trustee reveals the LLC, giving the owner some asset protection. Any more complex of a structure than this, and my opinion is that the administrative, accounting and tax burdens become too great to sustain long term.
Others: There are other strategies like Limited Partnerships, Limited Liability Limited Partnerships, Joint Venture Agreements, Self-Directed IRA, Life Insurance, Annuities, and other revocable trusts or irrevocable trusts. If you have questions about these other topics, please contact us to set up a free consultation.
Of course, overriding all of this, we would suggest regardless of the entity you decide to use to hold property, that you also purchase the proper insurance and in the proper amounts. However, becoming knowledgeable about these different structures will ultimately protect you from bogus (and legitimate) claims that could jeopardize your personal property, your real estate holdings, or both!
For more information on entity structuring, please contact us to schedule a free initial consultation to discuss your options at 813-774-5737 or email me directly at email@example.com. Please also check out the Crushing Debt book on Amazon. You can also subscribe to the Crushing Debt Podcast, on Apple Podcasts, Spotify, and other podcast players, including Amazon Echo (“Alexa”) for more free information about these topics.
Shawn M. Yesner, Esq., is the host of the Crushing Debt Podcast, author of the Crushing Debt book, and founder of Yesner Law, P.L., a Clearwater-based boutique real estate and consumer law firm that helps clients eliminate the financial bullies in their lives. We assist clients with asset protection, the sale and purchase of real property, Chapter 7 liquidation, Chapter 13 reorganization, bankruptcy, foreclosure defense, debt settlement, landlord/tenant issues, short sales, and loan modifications in Clearwater, Tampa, Westchase, Odessa, Oldsmar, Palm Harbor, Pinellas Park, Largo, St. Petersburg, and throughout the greater Tampa Bay area.