Corporate structures are meant to protect your assets and finances. In some cases, you may want to use different structures to deal with various aspects of your real estate business.
Essentially, your business structure should do its part to help make sure you don’t lose your property or profits under any circumstances. Here are some focal points to help you ensure your business remains healthy and profitable.
Corporations, either as a C corporation or an S corporation, reduce their owners’ liability. So putting a building and property rental business, for example, within a corporate structure limits the owners‘ personal liability. Generally there is no personal liability for the obligations of the business or any harm that results from corporate activities. This is called the corporate veil.
If, for example, your company is unable to pay its debts, the business assets would be open to creditors but your personal belongings would be off limits. However, you don’t have total protection from liability — if your company is in the business of offering advice, for example, you won’t be protected if the advice you personally offer is wrong.
Partnerships don’t provide as much protection. In a general partnership, all general partners are fully liable for the obligations of the business. In a limited partnership, general partners are liable but limited partners are not. In a limited liability company (LLC) there is generally no personal liability.
When you look at the different corporate structures from a tax perspective, a C corporation is at a disadvantage because it is taxed on income as well as profits. S corps are in a more favorable tax position because they pass the income through to the owners and don’t pay taxes in and of themselves.
The LLC is more flexible with members rather than shareholders. Work with your tax advisor and attorney to help you see how drafting a well thought-out membership agreement in an LLC can protect your interests. It could certainly play a role in how you structure the various parts of your real estate operations.
For example, one corporation could hold property and another hold the renovation and development business. That way, all of the construction is done under a separate corporate entity that does not own the building.
Use a Third Entity
If something goes wrong during a renovation, the liability of the company financing the construction would be limited for damages. Because the property is held by a separate corporate entity it is protected from any liability related to what might go wrong during renovations. A third entity, perhaps an LLC, could accept the income from the fully renovated rental real estate property.
The bottom line is that it’s better to be incorporated when you’re dealing with pricey real estate, because anything that’s not a corporation will offer less protection for the owners. However, an LLC offers more flexibility than an S corp and a better tax status than a C corp.
If you run a construction company as well as hold real estate, economies of scale can work to your favor in that regard by giving you better pricing and favorable treatment on insurance coverage than a one-off building owner.
If you own multiple buildings, and buy and sell real estate as well as working the buy-hold-rent business model, a like kind exchange from one LLC to another can offer significant tax savings that can be passed through to you and other owners.
Bear in mind that these structures are complex when it comes to taxation and you must consult with your accountant.