Entity Choices and Their Benefits...for the Real Estate Investor

Many individuals and/or families who are active in investing in real estate often expose themselves to liability and risk when they do not protect themselves by forming a business entity, such as a Family Limited Partnership ("FLP"), Limited Liability Company ("LLC"), or S-Corporation ("S-Corp"). There are many benefits that are afforded an entity that is incorporated...and the expense is truly negligible based upon the potential risk of not protecting the individual's personal assets.

Family Limited Partnership

The term "Family Limited Partnership" or "FLP", simply refers to a Limited Partnership that is tailored for use as an asset protection tool for a family. An FLP for your real estate investments can provide favorable tax benefits to real estate owners while providing a shield of protection for the real estate investment.

Benefits of Family Limited Partnerships for Real Estate Investors:

Limited Liability. An FLP differs from a General Partnership in that it offers limitations on liability for partnership debts and the acts of the other partners.

Minimize Income Taxes/Tax Benefits. By placing assets into a limited partnership, and making family members paid managers of the general partner corporation, it is sometimes possible to "spread" income among some non-close family members, thus placing some income with family members in a lower tax bracket.

Ease of Liquidation. Partnerships are usually easier to wind down and dissolve than any other business entities.

Minimize Liabilities for Debt. Limited partnerships have a separate class of partners - really, mere investors - called "limited partners", who are not liable for partnership debts.

Centralized Family Control. The FLP consolidates and centralizes control of family assets. Instead of simply passing down assets to the kids, the FLP allows the assets to be kept together, and changes in family control facilitated by simply changing the directors of the general partner corporation.

Inexpensive. The cost to form an FLP is insignificant compared with the money and time required to invest in real estate.

Separate Legal Entity: An FLP is recognized as a separate legal entity from its owners.

Privacy. Control of the limited partnership is generally not publicly disclosed. When a change of control is desired, the old managing family member simply resigns and a new managing family member assumes the job.

Protect your Assets. An FLP will protect you as an investor by limiting your risk exposure to the amount of the investment itself.

Limited Liability Company

Forming a Limited Liability Company for your real estate investments can provide favorable tax benefits to the real estate owners while providing a shield of protection for the selected endeavor. TIP: Many experts suggest that you hold each rental property in a separate Limited Liability Company (LLC) as a shield against lawsuits and for possible tax benefits.

Benefits of LLC formation for Real Estate Investors:

Inexpensive. The cost to form an LLC is insignificant compared with the money and time required to invest in real estate.
Separate Legal Entity: Like limited partnerships and corporations, an LLC is recognized as a separate legal entity from its "members."
Tax Benefits. Because an LLC is a pass-through entity, it is not subject to capital gains tax at the corporate level. As the owner of an LLC, the profit from the sale of a property would be passed through to you.
Protect your Assets. An LLC will protect you as an investor by limiting your risk exposure to the amount of the investment itself.
Limited Liability. As a general rule, LLC owners, known as members, are not liable for the debts and liabilities of the LLC beyond their invested capital, even if the members are directly involved in the LLC's management.
Easier than a Corporation. An LLC requires fewer corporate formalities, thereby making them easier to maintain than corporations.
Useful for "Buy and Hold" Investors. When you buy and hold real estate it is considered a capital asset. The primary goal for "buy and hold" investors is to achieve rental income and long-term capital appreciation.
Combination of Corporation and Partnership Attributes. An LLC is a hybrid between a partnership and a corporation in that it combines the "pass-through" treatment of a partnership with the limited liability accorded to corporate shareholders.
Attract Investors. It's easier to attract other investors into your operation under the LLC umbrella because they'll know your liability -- and theirs -- is limited.

S-Corporations

Forming an S-Corporation for your real estate investments can provide favorable tax benefits to real estate owners while providing a shield of protection for the real estate investment. TIP: Many experts suggest that you hold each rental property in a separate S-Corporation as a shield against lawsuits and for possible tax benefits.

Benefits of S-Corporation formation for Real Estate Investors:

Excellent for Short Term Investors. Some real estate investors engage in a business practice commonly called flipping real estate. This means the investors "buy and sell" real estate with the goal of turning a quick profit. When real estate is flipped it is considered inventory and the investor is considered a "dealer."

Avoid self-employment/Social Security Taxes. Real estate investors who flip real estate should consider forming an S-Corporation (or LLC taxable as an S-Corporation). This allows the dealer to avoid self-employment/social security tax on a portion of the profit earned from flipping real estate.

Inexpensive. The cost to form an LLC is insignificant compared with the money and time required to invest in real estate.

Separate Legal Entity: An S-Corporation is recognized as a separate legal entity from its owners.

Protect your Assets. An S-Corporation will protect you as an investor by limiting your risk exposure to the amount of the investment itself.

Attract Investors. It's easier to attract other investors into your operation under the S-Corporation umbrella because they'll know your liability -- and theirs -- is limited.

Tax Benefits. An S-Corp is taxed like a partnership or sole proprietorship rather than as a separate entity. Thus, the income is "passed-through" to the shareholders for purposes of computing tax liability, and the shareholder's individual tax returns will report the income or loss generated by the S-Corp.

Whatever entity type you choose, it is extremely important to protect your personal assets and limit your own risk. There are also extensive tax benefits! ...and the cost of incorporation is truly insignificant when compared with the downside potential!

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