Thursday, September 02, 2004

Legal Entity For Real Estate Investing

A reader writes:

I love this Blog-Thanks for having it. My question is: Why did you choose an LLC? What benefits does it give you? And lastly..did you obtain financing through your LLC name or your personal name? In a round about way I am also trying to find out if an LLC protects your personal assets. Are there other options beside the LLC? Thank you, Bill

Thanks for the kind words. All financing was done in my name. I have read how it is hard to get a bank to lend to a newly established LLC. You can try to get them to do it by personally guaranteeing the loan, but I didn't want to take the time to try that. Others have had success doing that however, so it's something to try. Remember, there are lots of lenders out there, so keep looking until you find one that will work with you.

An LLC will protect your assets. As with any legal entity, you need to make sure you follow the procedures correctly - never mix personal and business funds, always keep corporate meeting minutes (even if you are the only member of your company), etc. You need to treat your LLC as if it is a legitimate business. If you go to court and it looks to the judge like your company is merely an extension of your personal finances, the "corporate shield" will be pierced and your personal assets will no longer be protected.

As for the various entities, the main choices are an LLC or an S Corporation. (A C Corporation is another choice, but those are more expensive and have more legal bookkeeping requirements.) Opinions vary on which is the best, so do some research, especially research that is specific to your state. I choose an LLC because it is easy and cheap to set up (at least in Arizona), there are no yearly reporting requirements, no yearly filing fees, and it provides protection of personal assets. The IRS also considers it a "pass-through" entity. This means that, from the IRS' point of view, it does not exist. All profits and losses carry straight through to your personal tax return.

An S Corporation, on the other hand, is a tax-paying entity, so you will get double taxation of profits - once by the corporation when it earns money and once when you receive money from the corporation in the form of a distribution. There are also more legal filing requirements with an S Corporation. An S Corporation will also provide protection of personal assets.

Other entities are limited partnerships, trusts, and some others. There are a couple books in the Rich Dad series that are probably worth reading. Look for Loopholes Of The Rich by Diane Kennedy and Own Your Own Corporation by Garrett Sutton. I have not read either, but I have read stuff by both authors and respect them.

1 comment:

Anonymous said...

S-Corps are pass-thru entities at the Federal level. An S-corp never pays federal income tax. Many states also treat S-corp the same way-no tax, pass-thru to owners. Some states tax S-corps at a lower rate and I know of one that doesn't have an s-corp designation. What I've experienced:
CA - S-corp taxed at lower rate
DC - No S-corp
FL - pass-thru/no income tax
VA - pass-thru

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