If you’re thinking about turning your real estate investment projects into a business, you’ve got to really think about what kind of business you want it to be.
The right choice depends on your unique situation, but here are some key questions to ponder:
- How will I set up my real estate investment company?
- How many folks will co-own the business?
- What worries do I have about liability?
- How much do I care about tax perks?
- How much effort do I want to pour into building an overarching business entity?
Keep reading to explore the various types of business structures you should mull over, along with the pros and cons of each.
Types of Business Structures for Real Estate Investing
Starting a Real Estate Investment Sole Proprietorship
There are plenty of ways to structure your real estate investing business, and one of the simplest is a sole proprietorship. It’s straightforward—you’re not dealing with a separate legal entity, and as the owner, you’re personally responsible for everything, including debts. You can opt to do rehabs under your own name or a “trading as” name without diving into creating a new legal entity. While this route might seem like a breeze and easy on the wallet, there are some downsides.
A big one is that many real estate investment lenders might hesitate to lend directly to an individual due to legal constraints in certain states. Some states require loans to be made solely to a business entity. Another reason lenders might be wary is they want to steer clear of any chance that the loan could be seen as a consumer loan. Generally, private lenders have a strict rule against lending to individuals.
Operating as a sole proprietor also means you’re more exposed to liability in case of accidents on the property and greater financial risks.
Plus, there are fewer tax perks when you’re doing business under your own name compared to operating as a legal entity. Sure, sticking with your name might seem like the easiest route, but it might not be the safest or most cost-effective in the long run.
Starting a Real Estate Investment LLC or Lp
Two other common business entities for real estate investors are the limited liability company (LLC) and limited partnership (LP).
You can set up an LLC either as a single member (just you) or with multiple people forming a partnership-type LLC or LP.
An LP requires more than one person by definition.
Both LLCs and LPs offer some legal protection to their owners. Liability for accidents, finances, etc., falls on the LLC or the LP, with some limitations. They can also be structured as “pass-through” entities for tax purposes. What does this mean? It means the business itself isn’t taxed – all income, deductions, etc., are passed on to the individual partners.
However, it’s important to note that not all members of an LP are shielded from liability. Typically, LPs have both a general partner and limited partners. The limited partners invest in the business and share profits and losses but aren’t actively involved in managing the business. The general partner handles all management but remains liable for the LP’s obligations.
Starting a Real Estate Investment Corporation
Finally, some real estate investors opt for corporations. Although corporations offer the highest level of protection to owners, they’re also the priciest and most complicated to set up and keep up with. Typically, they’re taxed separately from their owners, instead of passing income directly to them.
Seek Advice From Professionals
You should definitely consult with both an attorney and an accountant to figure out the ideal real estate business structure for your situation.
An attorney will walk you through your options and highlight the legal pros and cons of each type of business setup.
Meanwhile, an accountant will clue you in on the tax benefits and obligations associated with different business structures—whether it’s a sole proprietorship, limited partnership, limited liability company, or corporation.
This guidance will help you make the right call. Plus, they’ll help you keep track of your business expenses and handle tax filings specific to your business type.
Choosing the right business entity for your real estate venture is crucial. If you’ve already put together a business plan as recommended by RFG, it should clearly spell out the chosen structure, along with an explanation of why it’s the best fit for your business.
It’s really important to stress that this is a key part of your business planning, and it needs to be approached with care, thoughtful consideration, and expert guidance.