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The Proper Entity for Your Real Estate Investing Business
| | Monday, June 16, 2003 @ 05:00 AM EDT
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Contributed by: Tim Randle
Tim Randle Properties
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First, let me state that I'm not an attorney and the rest of
this article is just based on my experiences.
Also, this article is not going to discuss land trusts,
which some of you may have just stumbled upon. A
land trust is not an entity. Although it is frequently used
in conjunction with entities, it is merely a paper device
used to shield property ownership from the public.
When I first got going, the recurring wisdom was
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that an
investor should use a C corp for cash deals. By cash
deals, I mean anything that throws off cash quickly. It
might be a wholesale flip, retail assignment, rehab and
retail, option, etc.
There were numerous reasons why this was and is
recommended. First, the C corp offers great liability
protection and allows the owner to take advantage of
fringe benefits, thus draining the corp of excess profits
through legitimate expenses.
What I've learned the hard way is that this entity is not
necessarily better for cash deals than other entities
unless you're doing serious cash numbers. By this I
mean that the added benefits that a C corp offers are
not available to you without a ton of cash coming in.
Stop and think about it for a moment. Are you going to
generate enough cash to pay normal operating expenses
like salary, marketing, funding, overhead, etc. and still
have cash remaining to set up company programs for
retirement, medical, insurance, education, etc.?
Typically, the answer's going to be "No", at least during
the formative years. The primary downside to a C corp
is that any losses, paper or otherwise, do not flow through
to your personal tax return. You don't get to use them
anytime soon.
When I started, the secondary recommendation for cash
deals was an S corp because it did offer many of the same
benefits as a C corp, yet allowed the owner to flow losses
through to the personal tax return. Once the business was
thriving then converting to a C corp was not difficult.
When I went through this research again about a year
ago, the majority of responses I received was that I should
use a Limited Partnership (LP) for cash deals with a Limited
Liability Company (LLC) as the General Partner (GP). I've
also heard others suggest using an S corp as the GP. Other
recommendations included using an LLC by itself as the
cash deal entity.
What about entities for the keepers? By that I mean any
property that hangs around for a while and doesn't cash
out soon. It could be a rental, lease option, or any property
with owner financing, including subject to (Sub2). What I
was told there was the same; that an LP with an LLC as
the GP was currently best.
The point here is that if you do spend the necessary time
to research this issue (and you should), you are likely to
get each of these responses and possibly more.
My experience is that any of these suggested entities is
better than starting with a C corp as I did. Factors that
should play into your decision process include setup costs
and any state-specific laws for each of the entities. For
example, in my state, Texas, the LLC is much cheaper to
set up than an LP. However, the LLC is also subject to
franchise taxes on gross receipts over 150k and the LP
is not.
Confused? I agree it's not easy to know what the right
course of action is. Do you need an entity or multiple
entities established before you do some deals? Absolutely
not. Why go to the trouble of setting up companies for a
business that you may decide to discontinue? How do you
know if you'll even like real estate investing until after you've
done some deals? Why do you need to set up serious
asset protection until you have something worth protecting?
My recommendation would be to begin to research the
various entities for your state as you continue to work
your investing business. In my opinion there's no need
to make things complicated in the initial stages. If there's
no obvious negatives to an LLC in your state, then perhaps
that would be a good start.
I would not rush out and set up a separate entity for cash
deals and a separate entity for keepers as I did. I would
not set up an LP as my first entity as it involves at least
two partners, one limited partner and one general
partner. Entities are not set in stone. With the proper
guidance and counsel from good attorneys and CPA's,
you can make changes to your business plans as the
business grows.
Again, this is not something you have to figure out when
just starting. Find someone very knowledgeable about real
estate investing, like John Hyre mentioned above, and
begin to ask the tough questions so you can make
informed decisions. As your business grows, your asset
protection can grow with it.
Thanks for reading. Until next time, good investing.
Sincerely,
Tim Randle
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