The Proper Entity for Your Real Estate Investing Business

First, let me state that I'm not an attorney and the rest of
this article is just based on my experiences.

Also, this article is not going to discuss land trusts,
which some of you may have just stumbled upon. A
land trust is not an entity. Although it is frequently used
in conjunction with entities, it is merely a paper device
used to shield property ownership from the public.

When I first got going, the recurring wisdom was that an

investor should use a C corp for cash deals. By cash

deals, I mean anything that throws off cash quickly. It

might be a wholesale flip, retail assignment, rehab and

retail, option, etc.


There were numerous reasons why this was and is

recommended. First, the C corp offers great liability

protection and allows the owner to take advantage of

fringe benefits, thus draining the corp of excess profits

through legitimate expenses.


What I've learned the hard way is that this entity is not

necessarily better for cash deals than other entities

unless you're doing serious cash numbers. By this I

mean that the added benefits that a C corp offers are

not available to you without a ton of cash coming in.


Stop and think about it for a moment. Are you going to

generate enough cash to pay normal operating expenses

like salary, marketing, funding, overhead, etc. and still

have cash remaining to set up company programs for

retirement, medical, insurance, education, etc.?


Typically, the answer's going to be "No", at least during

the formative years. The primary downside to a C corp

is that any losses, paper or otherwise, do not flow through

to your personal tax return. You don't get to use them

anytime soon.


When I started, the secondary recommendation for cash

deals was an S corp because it did offer many of the same

benefits as a C corp, yet allowed the owner to flow losses

through to the personal tax return. Once the business was

thriving then converting to a C corp was not difficult.


When I went through this research again about a year

ago, the majority of responses I received was that I should

use a Limited Partnership (LP) for cash deals with a Limited

Liability Company (LLC) as the General Partner (GP). I've

also heard others suggest using an S corp as the GP. Other

recommendations included using an LLC by itself as the

cash deal entity.


What about entities for the keepers? By that I mean any

property that hangs around for a while and doesn't cash

out soon. It could be a rental, lease option, or any property

with owner financing, including subject to (Sub2). What I

was told there was the same; that an LP with an LLC as

the GP was currently best.


The point here is that if you do spend the necessary time

to research this issue (and you should), you are likely to

get each of these responses and possibly more.


My experience is that any of these suggested entities is

better than starting with a C corp as I did. Factors that

should play into your decision process include setup costs

and any state-specific laws for each of the entities. For

example, in my state, Texas, the LLC is much cheaper to

set up than an LP. However, the LLC is also subject to

franchise taxes on gross receipts over 150k and the LP

is not.


Confused? I agree it's not easy to know what the right

course of action is. Do you need an entity or multiple

entities established before you do some deals? Absolutely

not. Why go to the trouble of setting up companies for a

business that you may decide to discontinue? How do you

know if you'll even like real estate investing until after you've

done some deals? Why do you need to set up serious

asset protection until you have something worth protecting?


My recommendation would be to begin to research the

various entities for your state as you continue to work

your investing business. In my opinion there's no need

to make things complicated in the initial stages. If there's

no obvious negatives to an LLC in your state, then perhaps

that would be a good start.


I would not rush out and set up a separate entity for cash

deals and a separate entity for keepers as I did. I would

not set up an LP as my first entity as it involves at least

two partners, one limited partner and one general

partner. Entities are not set in stone. With the proper

guidance and counsel from good attorneys and CPA's,

you can make changes to your business plans as the

business grows.


Again, this is not something you have to figure out when

just starting. Find someone very knowledgeable about real

estate investing, like John Hyre mentioned above, and

begin to ask the tough questions so you can make

informed decisions. As your business grows, your asset

protection can grow with it.


Thanks for reading. Until next time, good investing.


Sincerely,

Tim Randle