4 Legal Structures You Should Consider for Your Real Estate Investments

by | BiggerPockets.com

If you own a single piece of income-producing real estate, you’re probably fine without any kind of legal structure. But as you seriously consider growing your portfolio and adding investments, you’ll want to think long and hard about how you can legally protect yourself and simultaneously lower your tax implications.

What is a Legal Structure?

When it comes to the legal and financial side of real estate investments, you can’t afford to expose yourself to lots of liability and heavy taxation. While you have the option to run your venture as a simple proprietorship—filing income and expenses on your personal tax return—this is far from the best approach.

There needs to be some layer of protection between your business and your personal assets. A failure to establish legal safeguards in the form of a documented business structure could put your own personal assets—home, car, savings, etc.—at risk if you were to be sued or fall behind on debts.

A legal structure is simply some legal documentation that you wrap around your business to protect it. Assuming that you choose the proper one, you still have all of the freedoms to run your business as you see fit.

The 4 Structures You Should Consider

Let’s be clear about one thing: Every situation is different, and you’ll have to think about your specific needs and goals. But when viewed through a general, big picture lens, here are some of the best legal structures for real estate investors to consider.

Related: 10 Legal Disclosures I Include in My Rental Applications

1. LLC

For long-term investors, a limited liability company (LLC) is a great option. It’s perfect for buy-and-hold investments where you’re looking to accrue steady income and long-term capital appreciation. LLCs are simple and cheap to start, require very little paperwork, and—as the name indicates—limit the liability of the investor.

Another benefit of an LLC is that it’s a pass-through entity. In other words, earnings and losses are passed through to your own personal income tax return. This makes it simple to manage. But if you do go this route, you have to be extremely careful not to mix any persona and business expenses. Doing so will pierce the corporate veil and leave you personally liable.

2. S Corp

The S corp is a pass-through entity for tax purposes, similar to the LLC,” Incfile explains. “This means that the income generated by an S corporation will flow through to the personal income tax returns of the shareholders, and the S corp itself generally does not owe any tax liability.”

By structuring your real estate investment venture as an S corp, you get the flexibility to manage the ownership of the company. The stock of an S corp is transferrable (which is not the case in an LLC).

3. C Corp

A C corp is most different from both LLCs and S corps. They operate as true corporations that pay their own taxes. The biggest benefit is that there’s no cap on the number of owners. This makes it ideal if you’re pooling investors together for large real state investments. And because the earnings of the company don’t flow to your personal tax return, you don’t have to worry about income tax liability. However, this means there’s double taxation when you want to pull cash out.



Related: Is it Wise to Set Up an LLC When Starting in Real Estate Investing?

4. REIT

While not extremely common, it is possible to establish a non-publicly traded real estate investment trust (REIT). A REIT is very efficient and secure, but there’s one big trick. In order to qualify, the entity must distribute at least 90 percent of annual income to shareholders. This makes it hard to continue growing.

Think Long-Term

Whether you’re starting with a single property or have plans to accumulate hundreds of properties, it’s important that you think long-term when setting up a legal structure for your business. It’s far easier to set up a structure and grow into it than to reach a point down the road where you need to reincorporate. The latter can be expensive, time-consuming, and hard on a business.

If you’re unsure of how to proceed, consult with a small business attorney or consultant. Having someone with experience walk you through the pros and cons of each type of structure will help you wrap your mind around the best possible plan of action.

What legal protections do you prefer for your real estate assets? Why?

Comment below!

About Author

Larry Alton

Larry Alton is a professional blogger, writer and researcher who contributes to online media outlets and news sources. A graduate of Des Moines University, he still lives in Iowa as a full-time freelance writer and avid news hound. In addition to journalism, technical writing and in-depth research, he’s also active in his community and spends weekends volunteering with a local non-profit literacy organization and rock climbing.

8 Comments

  1. Christopher Smith

    Setting up an LLC in California is actually fairly expensive both to form and to operate (e.g., annual filing fees). You get pass through tax treatment regardless of whether you operate as a single member LLC or hold in your own name so no additional benefit there. Appropriate levels of insurance and management due diligence put into place can achieve significant liability mitigation. In the same vein, legal entity structures are by no means bullet proof when it come to liability management, and can be both cumbersome and lull one into a false sense of security.

  2. Daren D Wagner

    Great read. I struggle myself with these topics as well. Here is my story and let me know what you guys think…

    We have a duplex and a SFH rental in my name. Both have very high insurance and we have an umbrella policy.

    Also we have 3 SFH rentals that we have with an LLC with another partner, but those rentals are currently under our personal names on the deed and on the loan. We want to move all 3 over to the LLC in both the deed and the loan. But we found it very very hard to finance in our LLC, actually, we couldn’t get a loan because we did not have any assets or income in the LLC yet. Because of this we had to put the loans under our personal name. To make it more difficult our current lender wont allow us to deed any of them to the LLC.

    In my mind, from what I have read. Being “highly” above 50% leveraged, having it professionally managed, strong insurance and an umbrella policy, we are putting ourselves maybe not in the best position for taxes, but still in a good position in terms of liability.

    What are your thoughts/ideas? Do I go ahead and deed them anyway? Do we just let them ride until we have strong income and assets as an LLC, then go to get them refi’d?

    • NA Henson

      Daren D Wagner you have good points and most REIs will have trouble from time to time with title companies and/or lenders when trying to shield investment properties inside of an LLC or Series of a Series LLC. When this happens to me I find another title company or lender that “gets it” and is use to dealing with REIs. In some cases to get a deal done you go along with them however, asap you draft new deed to the entity (Series of a Series LLC) or a land trust (Deeds are effective as soon as they are signed) but do not file/record the new deed. This is called a “Dresser Drawer Deed” in my practice. It is most common in estate planning when you transfer homestead to a estate planning trust but do not record it until incapacity or death of the trust-maker. In my state one must purchase a new title insurance policy each time you purchase or re-fi and the title policy is the property of the named insured. For this reason never throw away your title policy from an old property you no longer own, title insurance goes with you (or your business entity or trust) not the real estate it was for.

      Another work around is for you to purchase or transfer title (if you already own it in your name) to name of a Land Trust. Title companies and lenders are use to seeing folks take title or transfer title to a name of a Trust, for example “Easy Street Trust”. However, on the Schedule or Exhibit “B”of the Trust agreement you list the beneficial owner(s) of the Trust. Schedule B on mine are a Series of a Series-LLC never an individual. The Trust is private, confidential agreement and is never filed in the county records. It is kept with the LLC records to show the company assets. This also works great on owner financed deals as you can later sell the property and no new title policy is needed because the title remains with the trust, you are merely switching out the name of the beneficial owner(s) of the Trust on schedule B. Hope this helps, sorry for typos

  3. Estelle Angelinas

    Which would be best for family members, all of who don’t live in the state where we’re investing in?
    My husband and I live in Greece. My youngest son and daughter-in-law live in the UK. My oldest son lives in CA.
    The properties we’re looking into are in Mi. Would an LLC be best or something else. We all have other personal assets in our areas. Houses, businesses, and farmland as well as stocks, and savings.

  4. NA Henson

    Michal Dworman is correct.
    This person is not a lawyer and is mixing formal business entities with IRS income tax elections. The Secretary of State Corporations division has no idea what election form you file with the IRS in choosing how your entity is to be taxed. C-Corp, S-Corp, Partnership, Sole Proprietorship.

    Establishment of a Corporation is one choice of entity. Depending on the intent or purpose of the business it is a for profit corporation or a non-profit corporation. Why I do not form nor would ever own my cash, securities, investment properties, intellectual property in a Corporation? Because a corporation does not have charging order protection. I can sue a corporation, get a money judgment against a corporation and put a lien on corporation assets or seek a turn over proceeding on its cash accounts. Corporations have Shareholders. LLCs have members.

    A Limit Liability Company (LLC) or a Series LLC (SLLC) are covered by the same Statute in my State and treated the same. Texas amended it LLC law in 2009 to allow Series LLCs following DE and 6 other States. Many more States followed since then. In my State this is the best choice of entity for most individuals, families, small to medium businesses for segregation and protection of assets of any type. LLCs and Series of a Series LLC have “charging order” protection from potential creditors. Why form an old fashioned LLC if your State has Series LLCs? Cost is the same for each entity to file a Certificate of Formation (name of form in Texas) in my State. $300. Registering a foreign entity to do business in my State costs $750. If my business asset is located in this state no good reason to form in another state then register in this state. A Series LLC allows its Manager to create new Series as Assets are purchased/added/gained in the business without further filing or cost. As a matter of law each business, asset is segregated from the other series of the Series LLC. Absent a crime or fraud no-piercing allowed. Texas Business Organization Code has rules on filing Assumed Name Certificates if you are using an alias so be in compliance. (not all States have Series-LLC)

    Please remember, a Corporation is not a Company, and a Company is not a Corporation. These are legally distinct business entities and names and users should not call one by the other. An LLC or a Series of a Series LLC must file a form in order to tell the IRS how it wants to be taxed. C-Corp, S-Corp, Partnership. Default for Multi-member LLC is partnership as I recall? This is a tax planning question for your expert tax planning person.

    The new Tax Cut and Jobs Act of 2018 has a new and direct impact on this IRS election. Is it now best to have your Series of a Series LLC taxed as a C-Corp at the 21% capped rate (must account for self-employment tax) or is it still best to elect the S-Corp status (limited # of members and non US Citizens not allowed) and be taxed as a pass through entity but taxed at your personal (higher than 21%?) rate? This is important question now we have one year down and also does your type of business qualify for the new 199A bonus depreciation? This a tax planning question for your expert tax planning person. Sorry for typos.

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