POINT # 1: Many investors believe that they can create a limited liability company (LLC) or file a corporate charter with the state and always have liability protection. This is simply not true. The truth is that each of these business entities (the LLC, the corporation and even the limited partnership) require certain key steps after the structure is created. I always like to compare business entities to a fancy Italian sports car or a new baby they will demand proper care and feeding! They are fun on the first day, but you had better know how to maintain them. You can't neglect the baby or take the fancy Italian sports car for a spin without any oil in the engine. If you do then a disaster is coming! Many new business owners believe that because they hired an attorney or service to create their new business entity, the work is done. The truth is that what you do after the entity is created is most important. There are countless nuisances, details, traps which must be understood in order to maintain liablity protection.
POINT # 2: If you plan on going into business with another investor or what you might call a partner, consider this: What happens if there is a disagreement? Do you have to sue, do you use mediation, do you have procedures in place to require efforts to settle things out of court? What happens if one of the parties in the business wants to sell their ownership interest? Who will buy it? What will they sell it for?
Here Is A Typical Scenario
Assume that you go into business with your best friend Tom. Things are going great but Tom decides that he needs to spend more time with his elderly parents. He wants to sell you his part of the business but you tell him, “Just wait a bit, Tom”. “Things will get less stressful soon”. He agrees but shakes his head in doubt. The next day you learn that he has sold shares in the business to his uncle. You now have a new co-owner. You never would have started the business if you were going to have to work with Tom's uncle. These types of situations can be avoided by utilizing proper ‘buy back' agreements between co-owners and limiting transfer rights. Sadly, most business owners never learn about these precautions until it is too late.
POINT # 3: For real estate investors there are always risks when the owner of a property decides to make repairs on the property or hire someone to make repairs for them. It does not matter if you have a business structure or not: A business owner is always personally liable for negligence. So if you are negligent when you make a repair or negligently ‘hire' someone to make a repair, you can be sued personally. Don't ever forget these words: “Business owners can be sued personally for negligent acts”. It's really important that you spend just as much time learning about the limitations of business entities, rather than just hearing about all the benefits!
Tax and Asset Protection Choices – Possible Contradictions?
POINT # 4: When trying to choose a business entity: Be Warned! There are a number of opinions out there depending on who you ask. I'll try to make this really simple so remember the following: You are fighting two battles. The business and tax structure you choose is your weapon/protector. What are these two battles?: 1) a tax battle and 2) a liability or asset protection battle. In other words, when you choose a business structure type (corporation, LLC, limited partnership) the choice for the real estate investor will depend on the tax issues which are associated with the business, and how well the business structure protects personal assets from the activities of the business. Certain structures can protect the assets of the business from personal liabilities (please see my article, ‘Corporations and Limited Liability Companies (LLC's): Charging Orders and the Differences in Protection'.
Most real estate investors will go to their attorney in order to find out which business structure makes the most sense from a legal standpoint. Usually the main question is, “Mr. Lawyer or Ms. Lawyer which business structure will protect my personal assets if my business is sued?”. Later that week, the same investor also travel across town to an accountant's office and ask, “Mr. Accountant or Ms. Accountant, which business structure will save me the most in taxes?”.
Notice A Few Things:
There could be different answers. Most attorneys will have a dynamite understanding of the legal issues (in this instance personal liability protection issues), however they may not be as informed on the complex tax issues associated with real estate or other industries. So their answer may be help you from a liability standpoint, but hurt you from a tax standpoint. The same is true regarding the accountant. They may have great choice for you when it comes to taxes, but a bad choice when it comes to personal liability protection. Usually, the biggest trap comes in the form of a good liability protection choice, but a horrible tax choice. This is especially true in real estate. If you ever receive conflicting advice be sure to understand exactly why it is conflicting. For example, are there really contradictions or perhaps is the professional giving you legal advice, but not considering the tax issues. The same is true regarding tax advice. I like to say that you need to educate yourself on all the options available and some of the most common issues and structures that investors like yourself use – day in and day out.
POINT # 5: All professionals are not created equally. In order choose a capable attorney or accountant you need to be able to evaluate them. How do you do this? An excellent way is to ask them questions which relate specifically to your business/industry. While some investors have a pretty good understanding of the tax and liability issues many do not. Because of this many business owners choose an inadequate attorney or accountant for their business. After all how can you evaluate the accountant or the attorney for you if you don't understand all your options? How can you really ask pertinent questions? How can you evaluate their skill level? How can you really be sure what they are telling you is up-to-date?
You really need to have some knowledge before you walk into the plush law or accounting office. It will not only help you make the right choices, but it can also Save You MOney! If the attorney does not have to create an entire set of forms for you then you will save several hundred dollars or more. If you have run your entity properly and understood accounting rules and IRS requirements, then there is less work for the accountant to do. With the right information you can choose the best professional and usually save a good deal in professional fees. You make your life and their job easier! Get educated first!