What Is A Legal Structure
When it comes to the legal and financial side of real estate investments, you cant afford to expose yourself to lots of liability and heavy taxation. While you have the option to run your venture as a simple proprietorshipfiling income and expenses on your personal tax returnthis is far from the best approach.
There needs to be some layer of protection between your business and your personal assets. A failure to establish legal safeguards in the form of a documented business structure could put your own personal assetshome, car, savings, etc.at risk if you were to be sued or fall behind on debts.
A legal structure is simply some legal documentation that you wrap around your business to protect it. Assuming that you choose the proper one, you still have all of the freedoms to run your business as you see fit.
Filing Taxes And A Disregarded Entity
Both business trusts and LLCs allow you to file taxes as a partnership or corporation. However, a business trust also allows you to file as a trust. A LLC will permit personal filing. When your business trust or LLC is filed as a partnership, they are required to file federal and state income tax returns. However, when a partnership consists of only one owner, they can be disregarded as an entity separate from its owner. When this occurs, the entity will not need to file certain income tax returns. For business trusts, being a disregarded entity means you will not have to file a federal nor a state tax return. For LLCs, however, most states will still require you to filed income tax returns.
Why Use A Business Trust Over An Llc
Your individual retirement account is a carefully crafted nest egg. If you have a self-directed IRA , you assume complete control over every aspect of your account. Each contribution, whether you made it pre- or post-taxes, is an investment you make in your future. Every buy or sale is a carefully crafted trade that took time, effort and money.
Although you may take risks related to your investments, did you know there were other dangers that may end up depleting your funds and impacting your future financial security? AtRoyal Legal Solutions, we understand how devastating it can be to lose your assets regardless of the reason. Below, we look at how setting up a business trust may be the best way for you to protect your investments.
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Should I Create An Investment Llc
Investment LLCs are most common for families, groups of friends, or partners, who want to pool their money for investment purposes. It is also possible for an individual to create an investment LLC.
Some typical types of investments made under an LLC include:
- Stocks, ETFs, and mutual funds
- Bonds, CDs, and fixed-income instruments
- Real estate
- Ownership of businesses
The LLC will protect each partys investment and personal assets and provide each party with tax benefits. If you choose to create an Investment LLC, one of the most critical formation documents is theLLC Operating Agreement .
The Bottom Line: Llcs Are Great For Established Investors But Less Useful For New Investors
Members can gain liability protection within their business entity by establishing an LLC. Your state government can give you an overview of your state’s specific LLC laws.
An LLC also offers privacy, limited liability, tax benefits and partnership opportunities. However, you need to watch out for ongoing costs, difficulty getting a mortgage, disadvantages with capital gains treatment and a few other cons.
First-time real estate investors may find it more advantageous to buy property in their own name because of the roadblocks and additional costs of buying a home with an LLC. Established investors should also tread carefully. They should consult a business attorney to determine the best legal structure for their investments.
Remember that it’s normal to feel analysis paralysis! To combat indecision, consider applying for a mortgage in your own name and working your way up to more complex investments.
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Multiple California Real Estate Llcs
If you have more than one piece of real estate, you can hold each property in its own separate LLC and treat each as a separate business.
Your personal assets will be protected from any liability arising from the property you own and each individual property will be protected from any liability that may arise from your ownership of other properties.
For example, if you own three different properties and put them all into one LLC, when there is a lawsuit involving any of the three properties, all three properties will be exposed to liability arising from the lawsuit. So, if someone were to be injured on property A, properties B and C will also be exposed to liability from that lawsuit and may potentially be lost to cover the damages.
However, if you put each of the three properties you own in its own LLC and treat each as its own business, each property will be insulated from the liabilities of the others.
So, if a lawsuit arises concerning property A, properties B and C will be insulated from that lawsuit. Likewise, if a lawsuit arises concerning property B, properties A and C will be insulated from that lawsuit, and so will your personal assets.
Does An Umbrella Policy Offer The Same Protection As An Llc
Landlords often try to mimic the liability protection of an LLC with insurance, specifically with an umbrella policy. An umbrella policy can help cover costs that go above your standard insurance policy. For example, lets say your insurance covers damages and lawsuits up to $250,000 dollars, but youre sued for $1 million. Your standard policy would not be sufficient and your personal assets would be at stake for the remaining balance. However, if you purchase an umbrella policy, it would help cover the remaining balance, adding more protection for your personal assets.
That being said, your umbrella policy will still have a limit. Your personal assets will be vulnerable if the lawsuit exceeds the umbrella policys coverage amount. Creating an LLC is a more effective way to protect your personal assets so they are never vulnerable during a lawsuit. Despite the additional work and costs of creating an LLC, this added protection is often worth it for landlords.
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Piercing The Corporate Veil
The primary benefit of forming a real estate LLC is the entitys ability to provide distance between you and the business while not relinquishing control.
Although forming a real estate LLC can provide an assortment of benefits, including liability protection, it can also be denied if mishandled. An LLC is simply the shell of a corporate structure, which means it will not be enough to avoid personal liability. This corporate shield can be shattered for those who engage in fraudulent activity or, most commonly, co-mingling personal and business fundsleaving you vulnerable to liability. Co-mingling funds makes it extremely hard to prove that your LLC is, in fact, a separate entity from you. That said, the importance of is second to none, as this small side-step can breach the conditions of a real estate LLC.
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Problems With Making Investments As An Individual
There are, however, many cases when the benefits associated with corporate structuring are more beneficial for passive investing. Not all corporate structures are complex. Many tax savings and liability avoidance strategies can be utilized by filling out a few simple forms.
Before diving deeper into some of the corporate structures that you could use, it is important to understand some of the problems associated with passive investing as an individual. Some of these issues include:
No ability to delegate: With a corporation, you can easily set up an authorized agent to sign documents and take other actions on your behalf.
Limited ability to deduct losses: Under the IRS code, investors are ordinarily unable to deduct more than $2,500 in investment losses on their tax returns. With a proper corporate structure, deductions can be unlimited and pass through to you as an individual.
Higher taxes: For certain types of investments, corporations can help to build wealth by reducing the effective tax rate that you have to pay on your investments. Corporations are especially beneficial when making investments in real estate or commercial assets.
Unlimited liability: As mentioned earlier in this article, you are liable for unlimited losses when you invest as an individual. When making investments in businesses or real estate, you should always use a corporation to avoid catastrophic losses when legal issues arise.
How To Form An Llc
Choose a name: Register a unique name in the state where you plan to do business. To make sure someone else doesnt have your business name, do a thorough search of online directories, county clerks offices and the secretary of states website in your state and any others in which you plan to do business. For a fee, many states let applicants reserve an LLC name for a set period of time before filing articles of organization.
Choose a registered agent: A registered agent is a person you designate to receive official correspondence for the LLC. Choose a registered agent before filing your articles of organization states generally require you to list a registered agents name and address on the form. Though people within the company usually can serve in this role, states maintain lists of third-party companies that perform registered-agent services.
File articles of organization: This step essentially brings your LLC into existence. States request basic pieces of information about your business, which, if youve thought through your business plan and structure, should not be hard to provide. Youll supply details such as a name, principal place of business and management type.
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How Do I Put Family Members On An Llc’s Payroll
The process of hiring family members is similar to hiring any other employee. You’ll need them to file a W-4, for instance, and you’ll withhold taxes from their pay as needed. However, there are some unusual tax situations when it comes to some family employees. For example, one spouse employed by the other spouse will have Medicare and Social Security taxes withheld, but not FUTA taxes.
The Reduction Of Personal Liability
When you use a business trust to invest, all investments and gains acquired under that entity are legally separated from your personal assets. This is beneficial for two reasons. If you use your business trust to invest in a property and default on the loan, this separation will protect your personal assets from any sort of legal ramifications. On the other hand, if you file for personal bankruptcy, your business trust assets are protected from the proceedings. LLCs, on the other hand, have limited personal liability. Furthermore, these protections are only active for as long as your LLC remains in compliance with regulations. All annual filings, fees, and requirements must be made or you lose this protection and invalidate the separation of assets.
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Fundamental Mistakes To Avoid When Starting An Llc For Real Estate
While forming a real estate LLC is immensely important for protection, the beginning stages of setting it up can also be massively intimidating for beginners. Also, there are several common mistakes that investors make along the way. To better assist in understanding the complexity of a real estate LLC, the following outlines the biggest mistakes people need to avoid when forming an LLC:
Not starting the process of forming your LLC before pursuing new deals.
Selecting the wrong LLC structure for your business.
Commingling personal and business funds, or engaging in unethical practices.
Not consulting a professional on the best corporate and tax structures for your business.
Omitting the proper steps and due diligence recommended when forming an LLC.
Underestimating ongoing costs and maintenance to keep the LLC up and running.
What Is An Investment Llc
An Investment LLC is a limited liability company that is established for the purpose of making investments. An LLC is a popular legal business entity because they are easy to create and provide the owner of the company with several benefits like liability protection and tax benefits.
Advantages of an LLC include:
- Easy to create
- Limited compliance laws
- Pass-through taxation
- Flexibility for the owner to choose management structure
LLCs can be created for any business purpose, whether running a brick and mortar store, purchasing and selling real estate, or investing.
Investment LLCs have been growing in popularity due to their various benefits to investors. It is common to have two or more people interested in ajoint venture for the purpose of investing.
An investment LLC will protect all partners involved in the company from liability. This allows multiple parties the opportunity to pool their money and profit not only from investments but from the various benefits offered by the limited liability company.
Read more about LLCs and their benefits by .
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How Do You Start An Llc
An LLC is fairly easy to start. It can be done online, by mail or fax by filing your Articles of Organization with the Secretary of State along with a $70 filing fee.
The Articles of Organization is the document used to create your LLC, which asks for basic information such as the name of the organization, location, names and addresses of the owner and a registered agent .
Next, you must also file a Statement of Information and an operating agreement. The operating agreement is simply a legal document detailing ownership and the operating procedures of the LLC.
Additionally, an Employment Identification Number must be obtained from the IRS. This is simply a 9-digit number used to identify your entity, similar to a social security number, except it is for the business.
Working With Providers That Allow Llcs To Invest
Not every financial provider or asset type is right for an LLC you will want to seek out financial providers that allow LLC investing. Most major brokerages do allow LLCs to buy and sell investments, though you will typically need to share your Operating Agreement with them.
Check brokerages like Fidelity, TD Ameritrade, Charles Schwab or Vanguard to see what their requirements are for investing via an LLC.
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What Is The Best Llc Structure For Your Rental Properties
Summary: Many real estate investors use limited liability companies to house their investment properties. This post covers the reasons you should consider putting your property in an LLC and contains an overview of our personal LLC structure. We also provide a checklist with step-by-step instructions for setting up your LLC.
A limited liability company is a business structure that allows for limited liability for its owners. LLCs are popular among real estate investors because they offer additional legal protection with the added benefit of flow-through taxation.
When we first started real estate investing, Kenji and I set up several LLCs to hold our real estate purchases. Over the years, we have continued to spend the time, money and effort to create additional LLCs because we believe the benefits of housing our properties within LLCs far outweigh the costs to create and maintain the structures.
The goal of this post is to cover the benefits of LLCs and to offer a real-life example of how to set up your LLCs, using our personal LLC structure as an example.
As a reference to use in this post, heres a diagram of how our LLCs are set up.
And with that, lets address why we put our properties in LLCs using this structure.
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Who Should Consider Buying A House With An Llc
For first-time real estate investors, buying a house with an LLC offers far more cons than pros. More experienced investors who plan to make a career out of real estate investing could benefit from using this strategy to advance their business. In particular, experienced investors can own a lot of real estate that protects them from personal liability.