Asset Protection for Real Estate Investors
Many real estate investors started out running their investing business as a sole proprietor because they really didn’t know any better. Most survived with only minimal damages, but quickly realized they needed to take the time to assess the best legal structure to use for real estate investing.
If you ask 10 experts you are likely to get 10 different opinions. With that in mind, here’s our opinion. Please don’t let our advice interfere with common sense and sensible business practice — ie, consult with your attorney or accountant (or the website of your state’s secretary of state) when choosing a business structure.
Many say that if you are a beginning investor, it’s probably best to not worry about asset protection until you actually have a few assets to protect. On this point we disagree. Our opinion is that you carefully consider the method(s) you will be acquiring and disposing of your real estate assets. Then huddle with your team/advisors and set up a business structure that will provide the best asset protection for the way you plan to run YOUR business. Why do we suggest getting the asset protection part done up front? Because you can turn around an investment deal faster than you can set up a business. Better to have your asset protection plan in place when you do the deal, than to try to go back and get everything re-done in the name of the business. Our recommendation is to never take title to investment property in your own name.
So, now that you’re going to structure that business, what structure should you take?
Assuming you want to set up an entity for handling your investment properties, the most popular are an LLC (Limited Liability Corporation) or a C Corporation. There is a lot of debate about which one is better. Many investors prefer the C Corporation because a certain amount off the top is taxed at 15percent and you can have a kick-butt employee (you) benefit plan to write off expenses. Others prefer the LLC, even though the income is passed through like a sole proprietor. The LLC is easy and inexpensive to establish, and just as easy to dissolve. In fact, we know investors who set up an LLC for each property they hold.
There are other ways to structure your business and shield your assets, but don’t even get us started on S Corps, or on the more complicated structures whereby you establish one entity which owns the others. Just trust us that you’ll want to talk it all over with a trained professional or a mentor.
Why is the tax issue such a big deal?
Here’s a simplified example using the C Corp. If you make $100K as a sole proprietor you are taxed on the full amount (35 percent) and have $65,000 left. Anything you buy for yourself comes from after-tax dollars. However, with a C Corporation if you could make the same $100K on paper, but have $50K in allowable expenses that you can write off. So you get taxed on that $50K at 15 percent and only have to pay $7,500 in taxes compared to $35,000 if it was your personal income being taxed. You still can buy the same stuff, but you are taxed less if you structure things correctly.
A very wealthy man once said It’s very hard for a C Corporation to make any money! What he meant was that C Corporations can expense almost everything until there is little or no profit.
Think about it… and then call a professional.