*Consult legal and tax advice before acting
New real estate investors get a ton of different answers – all of the place, when trying to decide which entity structure to use. The problem is that while the vast majority of investors are able to make a choice, they FAIL miserably at observing the formalities which come with their decision thereby defeating the whole point! Therefore, the MOST important question is – will I observe the formalities which are required by law?
What does the failure to observe formalities mean, you may ask? It means an aggressive plaintiffs lawyer can BLOW right through your entity and get to your personal assets. So, now that I have your attention I will briefly describe the choice of entities and then describe the way to make sure it will protect you!
Sole Proprietorship: This is where you have no barrier between your business and you. The main benefit of this structure is its simplicity. No extra fees or tax returns to file. The MAJOR downside is that your liability is unlimited. Meaning if you have non business assets they are generally exposed to business creditors.
C-Corps: The C-Corp evolved as a risk sharing mechanism. It solves the problem of being personally liable in almost all instances for the acts of your business. You can only can be liable up to the amount of your investment in the business as a shareholder. The central downside is double taxation. Taxation at the entity level and again on the personal level for dividends received.
S-Corps: The S-Corp evolved to address the double taxation. Certain corporations with few shareholders may elect Sub S to receive flow through taxation. Additionally, for fix and flips typically is THE best way to hold title in that you avoid self employment tax.
General Partnerships: This is very similar to the sole proprietorship but it involves two or more people. The central downfall here is that you have unlimited liability for business misdeeds or injury caused by your partners. It is still relatively low filing and tax requirements wise.
Limited Partnerships: This format is still used in that LP’s limited partners are liable only up to their investment. The general partners of this structure are generally a C-Corp or an LLC.
The Cadillac of them all…the LLC: The evolution of entities reached its zenith with the LLC. It can be taxed as a C Corp if you so chose or as a partnership…thus avoiding double taxation. It retains the liability protection.
Which should I choose? In most cases the LLC is a very wise choice dependent of the tax consequences of your business. However, coming back to our main point, if you do not observe corporate formalities you may get drilled with VEIL PIERCING. Check Back next week and I will define what it is and most of all give great tips to avoid it!!!
Douglas Dowell J.D. is commercial and multi-family investor. His areas of expertise are raising money legally, risk mitigation with due-diligence, and management science. Douglas is an avid student of success principals with a focus on modeling success factors.
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