How to Structure a Real Estate Business
Last Updated: October 11, 2023
Written by
Jasmine Roy
Jasmine Roy, BCS
Jasmine is a professional writer, editor, and SEO specialist with over five years of experience in content creation and digital marketing. In 2018, she completed her Bachelor of Communication Studies at MacEwan University in Edmonton, Alberta. She's been telling stories and passing on important information to the public ever since. Starting her career in journalism, Jasmine has always had a strong sense of civic engagement and the importance of law. Now, she uses her communication skills as a Marketing Writer and Editor at LawDepot.
Reviewed by
Sarah Ure
Sarah Ure, BA, JD
Sarah Ure is a Legal Writer at LawDepot. Sarah has undergraduate degrees in English and Psychology from the University of Calgary, as well as a Law degree from the University of Victoria. During her clinical terms at law school, Sarah was fortunate to help low-income clients in many different areas of law, including criminal law, family law, wills & estates, landlord & tenancy law, and environmental law. Sarah completed her articles in Toronto in 2015, then moved back to Alberta to begin her legal career. She worked with the Elizabeth Fry Society providing legal information to low-income clients, and later as a criminal defence lawyer, before being hired by LawDepot in 2019. Sarah is called to the bar in Ontario and Alberta. Sarah is a huge proponent of access to justice, and she is proud to use her legal and writing skills to create comprehensive, high-quality legal templates, available to people at a reasonable cost.
|
Fact checked by
Rebecca Koehn
Rebecca Koehn, BSc, MFA
Rebecca Koehn has been working in content creation and editing for over ten years and search engine optimization for over five years. Koehn is the Content Marketing Manager for LawDepot. After receiving her Bachelor of Science in Biological Sciences from the University of Alberta, Koehn decided to follow her love of writing and gained her Master of Fine Arts in Creative Writing and Publishing from Kingston University in London, England. Koehn is avid in digital journalism. She has produced content for LawDepot, Techopedia.com, Yogapedia.com, and has had her creative writing published in multiple digital anthologies. Koehn uses her background in sciences and arts to create high-quality content that sparks readers' interest and holds their attention from start to finish.
Key Takeaways:
- When scaling a rental business, it's crucial to consider different business structures to protect personal assets and minimize liabilities.
- LLCs are popular for owners with multiple properties because they offer anonymity, asset protection, and flexible tax options.
- Sole proprietorships suit owners with fewer properties, but there's an increased risk for personal liabilities.
Sure, a sole proprietorship works fine for many landlords. But scaling your rental business means taking on more risks and expenses.
Wonder what happens to your personal life and bank account if these things get out of control?
To reduce liability issues and unnecessary costs, it’s worth knowing how different business structures can protect your personal assets.
Learn about the pros and cons of forming a company, plus other tips for protecting your interests as you start and grow your real estate business.
What business entity is best for holding property?
Review these ways of structuring your business to see what’s right for you.
Sole proprietor
If you don’t register as another type of business entity, you’re operating as a sole proprietor by default. This structure works well when you have a couple of rental properties that are easy to maintain.
Remember, as a sole proprietor, you’re personally responsible for any mistakes or misfortunes related to your rental property. If you rely on rental income to pay the mortgage and a tenant is consistently late on rent, debt collectors may come after you for payments. This may negatively affect your personal savings or credit rating. What’s more, if tenants, occupants, or visitors get injured on your property, you may be the target of a lawsuit.
When it comes to taxes, sole proprietors include their business income on their personal tax return.
Partnership
Partnership is the default legal structure whenever two or more people start a business together.
Partners make it easier to deal with tenants and maintain properties, as you’ll have someone to split expenses and share profits with. Most importantly, partners share unlimited responsibility for any liabilities that their business incurs.
All of these reasons are what make it important to draft an agreement governing how your partnership will operate.
Any general partnership should have a contract. Without one, any applicable partnership law may have undesirable consequences. For example, if one partner retires, some laws automatically dissolve that partnership. However, the law allows partners to contract out of this provision.
On the other hand, you may wish to establish a Limited Liability Partnership (LLP) to hold your investment properties. This is a specific type of partnership suitable for certain business models.
In this case, the LLP is responsible for its own debts and liabilities, while its owners may only be liable up to a certain amount. The Partnership Agreement deals with how to divide ownership (e.g., equal to their capital contributions). Keep in mind, this doesn’t protect landlords from unlawful conduct.
Like sole proprietors, partners also typically add their business income to their individual tax returns (i.e., pass-through taxation). In some cases, this extra money may bump you into a higher tax bracket. To avoid paying higher taxes, some property owners separate their business income from their personal income by forming a company.
Limited liability company (LLC)
An LLC is a popular legal structure for holding real estate. This structure works well for individual homeowners and teams of people looking to own investment properties together.
An LLC offers several benefits to business owners:
- It provides anonymity. As the legal property owner, the LLC is often listed on the property title, financial contracts, and rental agreements.
- As a separate legal entity, the LLC shields the owners’ personal assets from being seized if the rental business runs into legal issues. Instead, only assets under the LLC’s ownership are subject to any such legal claims.
- It eases the process of property distribution after you pass away. Beneficiaries simply receive a certificate to prove their stake in the property.
- Money lenders and insurance companies may offer different contracts to an LLC than to an individual homeowner. For instance, as a company, you may qualify for more insurance coverage or low-interest-rate loans.
- It has a flexible tax status. If you meet certain criteria (e.g., single- or multi-member LLC), you can apply to have your company taxed as a corporation, a partnership, or a “disregarded entity”. (Note that some LLC members may need to pay self-employment tax.) If your LLC has high earnings, you may also be able to take advantage of corporate tax savings. Review your state’s LLC laws to see what applies to you.
- Multiple LLCs can help separate your liability between properties. So, if a lawsuit targets one property, it can only pursue the assets owned by that particular LLC. Besides, banks typically prefer separate LLCs to ensure that one property doesn’t negatively impact another property that they’re tied to.
If you own a few rental properties, this flexible business structure can give you the personal protection you need (with a smaller list of legal requirements than what comes with bigger corporations).
However, if you’re planning to build or flip several properties, you may want to incorporate your business instead.
However, if you’re planning to build or flip several properties, you may want to incorporate your business instead.
Corporation
A corporation is a company that has a structure of directors, executives, and shareholders.
So, if you often partner with certain contractors—or you have people invested in seeing you succeed—incorporating might be the next step in a long-term business relationship.
A corporation provides many of the same benefits as an LLC:
- Personal liability protection
- Corporate loan agreements
- Business tax deductions
Still, incorporating means meeting legal requirements at both the state and federal levels. This may mean less privacy and more red tape—so it’s important to research state laws where you do business. For instance, corporations must often comply with regulations on company operations, membership rules, report filings, and more.
Tax implications
A corporation gets taxed differently depending on its company structure.
While there are several different types of corporations, S-Corporations are a popular structure for real estate businesses. This is because an S-Corp avoids double-taxation (where a company pays taxes on its profits and its owners/shareholders pay taxes on their income and dividends).
It’s possible to save money by adjusting your company structure, but the ability to do so depends on your personal situation. Talk to a professional accountant to learn more about tax savings for your business.
What are the drawbacks of forming a real estate company?
Ok, we know what you’re thinking: If it takes less effort to run a sole proprietorship than it does to run a corporation or LLC, is it really worth it?
Let’s review some of the drawbacks to forming a company:
- There are fees to form a corporation or LLC in your state, including the recurring expenses that some states require for these structures. (However, many landlords find these initial costs worth the protection they’ll get from the company in the long term.)
- You’ll need to do some paperwork to start your company legally, plus some more paperwork to make managing the company easier... and potentially more paperwork as you continue your daily operations. (But you can take advantage of a document-building service like LawDepot to automate and simplify this process!)
- Your tax situation may get a little more complicated. Depending on your company structure, you may have to pay taxes twice: corporate taxes and personal taxes. (It helps to hire a professional to find the best structure for your business when it comes to saving money on taxes.)
- State and federal laws may regulate how you do business. For instance, federal laws require public companies to disclose certain details about their business. In addition to that, state laws may regulate how an LLC can enforce their landlord rights. For example, a landlord typically cannot represent their LLC in court during an eviction lawsuit (as this would be an unauthorized practice of law). Instead, the LLC must hire an attorney to argue the case.
Thankfully, you’ll only need to endure most of these drawbacks in the initial stages of setting up your company.
After deciding on a company structure, it’s important to transfer any property titles that you hold personally to your corporation.
How to transfer a property title to your company
You can transfer a property title by filing the right documents at your local county office of the clerk—but there are a few caveats that you should know about.
For one, you must always speak to your bank or money lender before transferring a title with a mortgage.
Banks often treat a property transfer in the same way as a property sale. As such, any mortgage agreement with a “due-on-sale” clause would require you to pay the remaining debt. On the other hand, if they don’t require this settlement, your bank will need to assess your LLC before allowing a lien transfer to take place.
You should also be aware of any tax charges on your property transfer (which vary by state). As always, consult an expert if you’re unsure of your legal responsibilities when transferring real estate.
When you’re ready, simply create your documents and follow your state’s process for transferring and registering deeds.
What other ways can a landlord limit liability?
Forming a corporation or LLC can limit a landlord’s personal liability and protect their assets, but there are other options as well:
- Landlord Insurance: Umbrella insurance policies add an extra layer of protection and cover liabilities such as vandalism, flood, and fire damage.
- Living Trust: Trust assets are meant for a beneficiary to inherit at a later point in time. Any claimants targeting a trust beneficiary typically can’t pursue these assets because they don’t belong to the beneficiary yet.
Of course, none of these options are bulletproof. Landlords cannot seek concrete liability protection if they neglect to provide safe, standard housing. Still, removing personal ownership and getting insurance are substantial steps to protecting your assets and interests.
Related Articles
