My partners and I (2 to 4 individuals) have identified a few properties that we would like to invest in. However, we are unsure of how to proceed in terms of the business. I’ve read talks about LLC’s and S-Corps and C-Corps and I would luv sound advice on which would make the best sense. I’ve always heard about each member creating their own LLC’s. Can any give any advice on the subject? Are there any places online that breaks it down in layman’s terms? Thanks.
LLCs can be very flexible business entities. Although laws do differ somewhat among states, you can generally form an LLC to be treated as a single owner proprietorship,
a partnership, a C Corp, or a Sub S Corp (or you can set up a C Corp Sub S corp, or partnership directly) The most useful thing in common to most investors using these types of entities is that it is intended to shield individuals forming the entity from personal liability from business conducted within the entity.
Some issues to think about:
C Corp and Sub S entities ( and LLCs that elect to be treated as such) require the employees (owners) to be paid a “reasonable” salary and that means also paying associated payroll taxes, but allows profit above those salaries to be distributed as dividends, which are not subject to payroll taxes. So if you are flipping without holding for at least 1 year and are not considered a “dealer” by the IRS, this can save considerable taxes.
If you are developing a rental portfolio of multiple properties, holding each property in a seperate LLC helps ensure that if that LLC is sued (and loses) the instigator of the suit can only attach assets associated with the 1 property in that 1 LLC. (other properties in other LLCs should not be able to be attached) However, if all equity in the property held in the LLC is mortgaged (I hold a 5 year balloon mortgage/2nd mortgage that requires no payments on every one of the properties owned by my LLCs to ensure there is no equity available in any property) there is no equity to sue for. The LLC is essentially “broke”.
Multi member LLCs and formal partnerships issues K-1 tax statements that are reported to be audited by the IRS at a much lower rate than 1040s or Sub-S statements.
Also, if the multi-member LLC or partnership is a correctly formed and is sued and loses, the settlement cannot be forced from the LLC/partnership but the winning party may be subject to taxes on the settlement and future earnings even if they don’t actually receive them. This helps reduce the incentive to even file a lawsuit.
There are many more issues to consider when selecting an entity to operate under. I would suggest reading everything you can on this site regarding this subject, as well as look at as many other sites as possible. Even then there may not be a absolute clear path to proceed. However, at that point you know enough to ask intelligent questions of an attorney who could help you or you could simply use your best judgment and select an entity that is a good fit for you. It may not be the BEST fit, but if you are just starting out or just starting to protect current investments, it isn’t unreasonable to find out in a year or so that your goals or situation has changes and the entity you paid $$$$$$$$ for the attorney to set up is no longer “optimum” anyway.
Work out all the details like who pays how much, who gets how much profit, who does what, what happens if someone doesn’t pull his weight, how the partnership will end, how does one cash out when the others want to stay in, etc. Then have an attorney who specializes in real estate partnersihp agreements draft the agreement.
Hi. I appreciate the responses. I have concluded that forming an LLC is the best course of action. However, my friend and I are undecided in whether to form seperate LLC’s with sole proprietorship taxation or to form a LLC together (partnership). We are definitely motivated to work together.
We have already located one property that we will like to make an offer on… but if we form seperate LLC’s, only one of us can basically purchase the property, right? How would the other individual have any stakes “profit/loss” in this property?
For this first property, I think it would be best if my friend and I formed an LLC (partnership) so we will feel equally involved in any profit/loss. But how complicated will our taxes become? Thanks.
but if we form seperate LLC's, only one of us can basically purchase the property, right? How would the other individual have any stakes "profit/loss" in this property?
your individual LLCs would have to form a partnership with each other (or a joint, 3rd LLC) and seek financing within this 3rd entity to share that risk. Then all you have done is added a layer of complexity on top of the relatively simple matter of forming an LLC with two members (you) and financing inside the LLC.
before you start all this, make sure you have a banker that will finance inside an entity with a personal guarantee. many “banks” won’t do this because it doesn’t fit their “fill in the blank” homeowner mortgages.