If you are a single real estate investor or a group of investors with an intention to establish a business, there are many considerations you will need to make. However, one of the most important decisions will involve determining the structure of your business that limits your personal liability and ensures protection of personal assets. There are several types of business entities that exempt their owners from personal liability and safeguard their investment assets.
– S Corporations are legal entities established for real estate investing purposes as investment conduits. By issuing stock, corporations amass capital from single investors, including small investors, which allows for investments on a large scale. Even though S corporations eliminate the double taxation feature of the regular, C Corporations—under which both corporation and individual owners pay income taxes—they are still required to pay taxes on property sold. Moreover, while they limit personal liability, S Corporations may be seized by creditors along with any real estate holdings registered under their name.
– Limited Liability Corporations (LLC) also offer protection from personal liability and are very easy and inexpensive to establish. Moreover, an LLC is credited with simplicity as it does not involve some of the formalities of a corporation. It also has an advantage over the S Corporation because all its profit or loss can be included on the individual’s 1040 tax return. Once the property ownership is transferred from investors to the LLC, the LLC becomes the owner of the property, thereby limiting personal liability of the individual property owner.
However, there are some deficiencies of an LLC. When the real property is transferred to the LLC, the lender may allow the LLC to assume the loan and mortgage, either with or without any modifications to the loan terms. However, a lender may require that the LLC refinance with a new mortgage on behalf of a legal entity. Besides, if allowed to maintain the existing mortgage under the original owners, an LLC that wants to use the property as collateral for a new loan may be required by a bank to have its member(s) provide a personal guarantee or additional collateral.
– Land Trusts are revocable contracts whereby one party (the trustee) agrees to hold title on real property for the benefit of another party (the beneficiary). Beneficiaries of the trust retain management, control, and the right to income from the property. The trustee, which is often an attorney, law firm, or bank, is legally prohibited to disclose the identity of the true real property owners. Because the trustees do not have the property use rights, they cannot do anything with the property without an explicit, written approval from the beneficiaries.
The beneficiaries can revoke or cancel the trust agreement anytime. The land trust, for which there is generally no legal registration requirement, is superior to other forms of business forms because it provides asset protection by ensuring full secrecy of ownership. This may be enough to discourage potential litigants. The ownership records are released only if a subpoena is issued. Real estate in a trust is protected from judgments and liens against the true owners.
These types of business establishments offer protection from personal liability and protect personal assets to various degrees. They also have certain advantages over other types of business establishments, primarily because of tax and other benefits they offer. Still, the right form of establishment for your business will depend on your desired investment objectives, the number of parties involved in your business venture, and the degree of required protection for your personal holdings.
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