Corporate Entities – Which One Should You Use for Your Investment Property?
One of the decisions you’ll have to make when you start investing in real estate is whether or not you want to create a corporate entity to house your investments. There are lots of arguments for doing this, with the biggest being the protection they afford you against personal risk, as well as the tax benefits associated with them.
However, there isn’t just one type of entity available to you. There are several, and you must decide which legal structure is best-suited for you and your investment strategy.
Forming a limited liability company, or LLC, is one of the most common ways investors house their properties. Why? Because the LLC protects the property owner from lawsuits. They limit the investor’s personal liability in the event of an accident or other lawsuit-triggering situation at the property. LLCs also have pass-through taxation, which means the property owner does not have to pay business taxes. Rather, profits and losses are paid at a lower tax rate, which results in significant savings to the investor. However, LLCs aren’t all rainbows and sunshine. They cost money to set up and maintain, and it can also be difficult to obtain financing for a property that will be owned by an LLC. Plus, there’s no 100% guarantee that the LLC will protect personal assets in the event of a lawsuit – there are some instances where assets can still be seized.
Like the LLC, investors using an S Corporation also benefit from pass-through taxation. S Corps also offer liability protection so that investors’ personal assets are kept secure. The main difference between the S Corp and the LLC is in ownership and management structures. S Corps are limited to 100 shareholders, whereas LLCs can have as many people involved as desired. For the average real estate investor, this isn’t usually an issue. What can be an issue for some investors, though, is that anyone setting up an S Corp must have U.S. citizenship. Overseas investing has grown dramatically, so this is something foreign investors must be aware of. Unlike LLCs, S Corps also require certain formalities, like adoption of bylaws, issuing stock, and holding shareholder meetings.
Another option is the limited partnership. These are usually structured with a property manager or developer serving as the general partner, and investors coming into the partnership to supply capital in exchange for a share of the ownership. The major advantage for investors here is the reduced risk; they are only liable for the amount of money they contributed. Their role is also a more passive one as they are able to share in the profits/losses without playing an active, day-to-day role in the business. If an investor does decide to become more active, however, they may become a general partner, which will increase their liability.
There are a just a few of the options available to investors who don’t wish to buy property as an individual. Before opening any type of legal entity, it’s important to speak with a tax advisor to learn more about each option. A professional will be able to advise you of the legal intricacies involved with each, as well as which type will align best with your investment strategy.