Entity Choice for Real Estate Investors - PowerPoint Presentation

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Entity Choice for Real Estate Investors

Presented by

Alfonso Zambrano

© 2017 Brown & Fortunato, P.C.

Disclaimer

The following

presentation includes generalized information.

Choosing an entity for your real estate investment or business will require you to make a choice depending on the specific facts of your situation. Contact your attorney and CPA to set up the best structure for your business.I am not a Tax Attorney, CPA or Financial Advisor.I am only licensed to practice law in Texas.

Choice of Entity

The greatest advantage to choosing a legal entity to set up your business is that you will not be personally liable for the debts and claims of the business. Choosing a legal entity will protect your personal assets.

Real Estate is a “HOT” asset.

Insurance is not always enough. LeBron James example.

Types of Ownership Structures

Sole Proprietorship

General Partnership

Limited Liability PartnershipLimited Liability CompanyCorporation – “C” or “S”

Sole Proprietorship

Advantages

Simple to create. No state filing required.

Simple to manage. No mandatory meetings, you are the only person who can legally obligate the business. Disadvantages

UNLIMITED personal liability.

Ownership Restrictions: There can only be one sole proprietor.

Automatic dissolution upon death or departure of the sole proprietor.

Difficult to sell to a potential buyer because he or she may not want personal liability.

Subject to self-employment taxes.

Increased IRS examination risk.

General Partnership

Advantages

Simple To

Create. No state filing required. A partnership agreement is recommended, but not required. Meetings are not required. Flexibility in Management Structure. Any general partner can make management decisions.

Disadvantages

UNLIMITED liability of general partners.

Subject to self-employment taxes.

Limited Partnership (LP)

Advantages

Limited liability for limited partners

.Centralized management. Any general partner can make management decisions. Disadvantages

Unlimited liability for general partner(s). However, the general partner(s) of an LP can be a legal entity.

Must file with state. Filing fees are $750.

Must

keep up with formalities in order to avoid piercing the corporate veil.

Subject to self-employment taxes.

Could be difficult to receive financing.

Limited Liability Company (LLC)

Advantages

Limited liability of members.

Flexibility in organizational and management structure. Can structure as member-managed or manager-managed. Texas allows single-member LLCs.

Choice of taxation.

Disadvantages

Articles must be filed with the Secretary of State.

Filing fees are $300. Certain

records are required to be maintained

.

Must keep up with formalities in order to avoid piercing the corporate veil. Could be difficult to receive financing and subject to self-employment taxes if LLC is taxed as a disregarded entity.

“C” Corporation

Advantages

No personal liability of shareholders.

Corporation continues upon death or departure of a shareholder. Easier to get financing for your business because your lender will look at the corporate tax return, not your personal tax return.

Disadvantages

Inflexible management structure.

Must file with the Secretary of State. Filings fees are $300.

Must keep up with strict formalities, such as required bylaws and annual meetings, in order to avoid piercing the corporate veil.

Double taxation (taxed at the corporate and individual level).

“S” Corporation*

Advantages

No personal liability of shareholders/members/partners.

Single level taxation, no double taxation as with a “C” Corporation.Disadvantages

Most likely will have to file with the Secretary of State. Filings fees are $300.

Must keep up with formalities in order to avoid piercing the corporate veil.

Ownership restrictions: No more than 100 shareholders/members/partners; no domestic or foreign entities or nonresident aliens allowed.

*

An “S” Corporation is

NOT

an entity at all, but the name by which a method of federal income taxation is described. This method of federal taxation may be used by four forms of Texas entities: corporations, professional associations, limited liability companies,

and general partnerships.

Choosing the Best Entity forYour Real Estate Business

Buy and Hold

: Typically an LLC will be the best entity because rentals in LLCs get many tax benefits and are cheaper and easier to run than a LLP.

Flippers: Typically an LLC will be the best entity. A flipper will want to consider his or her tax implications and whether it is best to be taxed as a disregarded entity or as an S Corporation.Wholesalers: Typically either an LLC taxed as an S Corporation or an S Corporation will be the best entity choices.Property Management Companies

: Typically either an LLC taxed as an S Corporation or an S corporation will be the best entity choices.

Contractors

: Typically either an LLC taxed as an S Corporation or an S Corporation will be the best entity choices.

Multiple Real Estate Activities

If your company is participating in multiple real estate activities, you will want to separate entities in order to minimize your liability and tax implications, depending on the activity.

For example, create one entity for active investing (wholesale and rehab flips) and another entity for passive investing (rentals, owner financing, and lease options).

This allows your passive investment activities to enjoy the many tax benefits offered by the IRS.

Why LLCs Are Often Used by Real Estate Investors

LLCs have many benefits, including:

Low formation costs.

Limited liability. Flexibility in management and ownership structure.

Choice of tax implications.

General Tax Information

Active v. Passive Real Estate Investing

Single v. Double Taxation (i.e., Corporations)

Employment and Self-Employment TaxesEmployee taxes such as federal income tax, FICA, and FUTAGoing into business with your spouseSelf-employment tax

General Tax Information

Tax Elections:

For Subchapter C taxation, the available entities include: corporation, general partnership, limited liability partnership, and LLC.

For Subchapter S taxation, the available entities include: corporation, general partnership, and LLC.For Subchapter K taxation, the available entities include: general partnership, limited liability partnership, and LLC.For disregarded status, the only entity is an LLC with a single member and the non-entity of sole-proprietorship.

General Estate Planning Information

Using an LLC or LLP can allow you to set up certain structures to transfer your assets to your heirs to avoid taxes and maintain control until you are ready for your heirs to receive the assets.

Sol

e Proprietorship

General Partnership

Limited Partnership

Limited Liability Company

C

Corporation

Personal Liability

Sole

proprietor is personally liable

General partners are personally liable

General partner(s) is

(are) personally liable. Limited partners are not personally liable.

Limited liability

Limited liability

Who Can Legally Obligate the Business

Sole

proprietor

Any general partner

Any general partner, not limited

partners

In member-managed,

any member. In manager-managed, any manager

Officers and Directors

Responsibility for Management Decisions

Sole proprietor

General

partners

Any general partner, not limited partners

In member-managed, any member.

In manager-managed, any manager

Board

of Directors and Officers

Ownership Restrictions

Only

one sole proprietor

At least 2 general partners

At least 1 general partner

and at least 1 limited partner

Texas allows single member LLCs

Texas allows one

or more shareholders

Sole Proprietorship

General Partnership

Limited Partnership

Limited Liability Company

C Corporation

Start-up and ongoing formalities

No state filing; no meetings required

No state filing; partnership

agreement recommended, no meetings required

Must file Form 207 (Certificate of Formation) with Secretary of State;

Filing fee is $750; Few requirements regarding mandatory recordkeeping

Must file Form 205 (Certificate of Formation) with Secretary of State; Filing fee is $300; Few

requirements regarding mandatory recordkeeping

Mus

t file Form 201 (Certificate of Formation) with Secretary of State; Filing fee is $300; bylaws and annual meetings required

Limits on Transferability of Interests

Can

sell business to another, but may be difficult due to personal liability risk

A partner may transfer all or part of the partner’s partnership interest

A partner may transfer all or part of the partner’s partnership interest

An assignee of a membership interest in an LLC is entitled to become a member of

the company on approval of all the company’s members

Transfers may be limited by agreement or by securities

law

Effect

of Death or Departure of Owner

Automatic

dissolution

A partnership continues after an event of withdrawal.

If

there are no remaining general partners following withdrawal of a general partner, the partnership may be reconstituted.

A limited partner may withdraw from a LP only at the time or on the occurrence of an event specified in a written partnership

agreement.

A member of a LLC may not withdraw or be expelled from the company. Termination of the last remaining member will cause LLC to wind up unless representative or successor

agrees to continue the LLC

Corporation continues

Taxation of Business Profits

Individual

tax rate of sole proprietor

Individual

tax rates of general partners

Individual tax rates of general and limited partners

Individual tax rates of members unless LLC

elects corporate taxation

Corporation

profits taxed at corporate rates; dividends taxed at individual rates of shareholders = double taxation

Summary

Every business is different. The way you choose to structure your business should be developed with your specific business activities, purposes, and organization in mind.

Contact your attorney and CPA to help structure your business in a way that will give you the most benefits.

Implications to consider when structuring your business: Do you have employees? How many owners do you have?

How many properties do you own?

What is your risk tolerance?

What sorts of investment activities will your business participate in?

What management style do you prefer?

What are your goals for the future of your business?

Estate planning needs/goals?

Exit strategies?

Alfonso ZambranoBrown & Fortunato, P.C.

Tel: (806) 345-6354

Email:

azambrano@bf-law.comLinkedIn: https://www.linkedin.com/in/azambrano1