How should I hold my real estate investments, in an entity or in my individual name?
This is the single most asked question I get as a lawyer. There is no “right” way to hold real estate and it is up to the individuals who are buying the real estate. BUT, make sure that you have looked at all options and that you understand all those options. To better understand the options it is important to ask one question: What is your goal?
To many people, this question may seem to have an obvious answer, but it really does not. This question has layers to it that peel away like the layers of an onion. There are tax consequences to consider, asset protection concerns, and even municipal/city code considerations that have to be taken into account for holding real estate in your individual name or in an entity. Below are the most common entities that real estate investors utilize to hold their investment properties. The descriptions are not exhaustive and each one is akin to running down a rabbit hole of nuance and intricacies. These descriptions are simply an overview.
A limited liability company (“LLC”) is a popular method of buying, selling, and holding real estate. Why? Because the owners (Members) are not personally responsible for the company’s debts or liabilities. LLCs are a hybrid of the corporate protections afforded to Corporations and the tax benefits of a partnership. Regulations pertaining to LLCs vary from state to state. Below is a primer on the basics of LLCs.
A Single Member Limited Liability Company is considered a disregarded entity for tax purposes. What does that mean? Well, in short, it means that the protections of the Limited Liability Company are provided to the Single Member (YOU) while the tax consequences pass through the entity to the appropriate schedule on your 1040 tax return. In essence, the IRS looks at this form of entity as though it is not there.
A Multi Member Limited Liability Company is simply a Limited Liability company with multiple members, individuals or other entities. The taxation of this entity is still treated as a “pass through” entity with the MMLLC providing a K-1 to the members that shows them their interest, share or percentage, of the profits and losses to be reported on their respective tax returns.
A Series Limited Liability Company is a Limited Liability Company that was created to create more efficiency in the LLC regime by allowing one entity to hold multiple properties under the umbrella of a single LLC. Within that single LLC there are series that assign to each property tranche its own tax identification, books, and bank accounts. The same protections apply to this entity as to the other types of LLCs but instead of paying multiple annual fees to the state agencies, it would pay one.
An S Corporation that enjoys limited liability and is a Pass-Through entity that is itself not subject to tax BUT it is limited to 100 stockholders that cannot be partnerships, corporations or non-resident alien shareholders. This type of entity has only one class of stock and is a domestic corporation. The profits and losses pass through to the individual shareholders on a K-1. This entity files a Form 1120S return with the IRS and the shareholders must report their profits and losses reported to them on their K-1s on the appropriate schedule on their 1040 tax returns.
A C Corporation is an entity that is taxed at the corporate level and enjoys limited liability. However, it is NOT a pass-through entity. Thus, the profits and losses of the Corporation do not pass through to the shareholders.
A trust can be of several forms but to simplify it I will simply categorize them as Revocable and Irrevocable. Revocable trusts are those that the Grantor (You) can control and would still be included in your estate upon your passing. There are few protections with this form of trust. An Irrevocable Trust is one that you do not control, generally, and have no direct control over since you have assigned the ownership of property to that Trust. Since the property is no longer in your name, you do not own it and are not liable for it any longer. Books have been written about trusts and this area of law actually is a niche unto itself. Trusts are very clean and effective ways to enjoy the benefits of asset protection, estate planning, and to receive the proceeds of the largesse of the trust. Trusts file their own returns and the beneficiaries report their income from trusts on their tax returns.
A partnership is an agreement by more than one person to endeavor to make money together in a business enterprise. Partnerships can be general, limited, limited liability partnership and LLC Partnership.
Typically, the partners manage the business and assume responsibility for the partnership’s debts. Personal assets are at risk in a general partnership and the partners are responsible for the each other’s actions.
These partnerships are more structured and have both general and limited partners. Limited partners are usually only investors while the General Partners are those that own and operate the company and assume the liabilities for the partnership.
This type of partnership are those that the partners are not held liable for the debts of the of the partnership and have not responsibility for the actions of the other partners. The protections vary from state to state so make sure you check with a lawyer.
LLCs can be and usually are taxed as partnerships. In most cases, the members cannot be sued for the business’s actions or debts, however, the members can be liable for the actions of other members.
Another option, is to hold the property in your individual name, buy insurance and be cautious. This exposes your personal assets in the event you are sued.
Entity choice is dependent on the investor. Speak with your team about what is best for you. As you can see, there are a variety of ways to hold real estate. It’s a business decision and one that should be considered and chosen with the help of professionals.
Brian is a licensed attorney in Tennessee who handles commercial, real estate, construction, and business issues for clients. He and his wife also invest in real estate. To learn more about Brian, visit www.boydlegal.co
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.