How does my real estate business benefit from forming a separate legal entity?
There are several advantages to making a separate legal entity for your real estate business. Although there may be some upfront cost and periodic administration, the effort is usually worth it.
In general, your new real estate business will take one of these forms:
- Limited liability company (LLC): An LLC is one of the easiest legal entities to form and maintain. It also has lower upkeep costs and stellar asset protection.
- S Corporation: An S-corp is a corporation, but it is treated as a pass-through entity for tax purposes, which makes it ideal for small business owners.
- C Corporation: A C-corp is a traditional corporation with some tax advantages not available to other entities, but it requires significant maintenance and typically has higher upkeep costs.
No matter which of the above entity types you choose, it will generally have the following benefits:
Personal asset protection
In general, those who go into the real estate business usually buy and sell properties or lease properties. Both of these business strategies carry risk. When fixing up properties to sell, contractors and others could be injured or cause property damage. Similarly, in residential or commercial rental properties, tenants could sustain injuries or cause property damage.
When you form a separate legal entity to hold the real estate, third party liability generally stops with the legal entity you formed. The business shields your personal assets from a negative court ruling or judgment. Without a separate legal entity or structure, your personal assets are at risk.
By creating a corporation or LLC to operate the real estate business, you limit liability to whatever property the company holds. Limiting liability in this way decreases risk overall and protects your personal assets.
Increased legitimacy for the company
Whether you form an LLC or corporation for your real estate business, it can improve your venture’s legitimacy, which attracts lenders, investors, buyers or renters. A distinct legal business entity demonstrates intent and seriousness, and shows the world your business plans to stick around.
Ownership transfer and long-term planning
It is easier to transfer ownership of a corporation or LLC than the business assets of a sole proprietorship. When you want to retire or sell your business, you can sell the shares of the corporation or LLC membership units instead of disposing of the property or leaving it to your heirs to resolve.
What entity type is right for my real estate business?
Every real estate business is different. There is no one-size-fits-all solution. Instead, consider your goals and what benefits or advantages are important to you. It can be helpful to revisit or make a formal Business Plan before taking the next step.
Rental property owners
Rental property owners charge rent based on prevailing market rates and costs to maintain the property. In general, rental property owners may receive the most benefit by making an LLC for each rental property.
Individual LLCs limit liability to just the actual property each LLC possesses, along with any other assets the LLC owns. Because LLCs are relatively easy to form and maintain, several LLCs are more manageable than several corporations. LLCs also work well for single owners or small groups of partners.
Property flippers
Those who flip property buy a piece of property, fix it up, and sell it. They may hold multiple properties, but many focus on just one project at a time. Many property flippers will benefit from creating a single LLC or S-corporation for their business.
The main difference between an LLC and an S-corp is administrative maintenance. An S-corp has annual member meetings, bylaws, meeting minutes, and other corporate records. LLCs do not have as many requirements. S-corps tend to work better for property flippers who have multiple projects at any given time. If you flip properties with a friend, an S-corp may be a good idea. If you are on your own, an LLC may work just fine.
Property management companies
Some real estate businesses focus their efforts on property management for third parties. These services might include buying and selling on behalf of someone else, maintaining rental properties, or coordinating efforts to improve or remodel properties.
In some states, property management companies must hold a real estate broker’s license. If applicable, an individual’s broker license can apply to the business or the business may need its own dedicated license. Working with an attorney can help you be compliant with state and local laws.
Is a separate business entity required if I am renting a room or other space in my home?
In general, no. In fact, the benefits of creating a separate entity may not outweigh the costs. In some cases, you may obtain separate insurance to address many of the liability concerns that come from sharing your home with a renter.
All bets are off, however, if you rent out your property for an event. For example, if you host weddings or other gatherings the potential for liability is higher. In that situation, it might be worth the cost and effort to form a separate legal entity to ensure your personal property is not at risk.
Can my real estate business pay me rent for my property?
Yes, your real estate business can pay rent to you for leasing your personal property. There are, however, some restrictions on “self-renting” for tax purposes. These IRS rules can decrease or eliminate the tax benefits that you otherwise would have gained.
Some might want to set up this arrangement because their lender will not permit a change in property ownership. In some situations, you may transfer the loan to the LLC if you remain an individual guarantor. A land trust might be another option.
If you have more questions about the right type of business entity to form for your real estate business, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
