Why Creating a Business Entity is Crucial for Real Estate Investing
(Disclaimer: The content of this article is not intended as financial or investment advice but rather information for educational purposes only.)
This article is based on the episode of the Building Equity podcast “ Creating The Right Business Entity for Real Estate Investing” with Mr. Jeffrey Grant, a real estate attorney from the law firm of Grant, Cottrell & Miller-Myers in Naples, Florida. Click here to watch the episode.
Investing in stocks and bonds has always been considered the smarter, more prudent strategy for generating long-term profits while real estate was always stigmatized as the riskier venture for investors. But over the past few years, the industry has seen a momentous shift in investment approaches. Whether it is global impact or common market volatility, stocks and bonds are shaping up as the more precarious investment strategy.
While individuals are seeing drastic fluctuations in their retirement portfolios when it comes to stocks and bonds, reporting as high as 10% returns to as low as 20% losses, investors holding real estate are experiencing consistent positive returns with no impact from outside influences. As uncertain times continue to surround the markets, real estate has emerged as the more shrewd, beneficial investment strategy, yielding bigger, more steady returns with less risk.
Protect Your Real Estate Investment with a Business Entity
While investing in real estate is clearly becoming the smarter strategy, investors looking to purchase properties in their names should strongly consider against it. From succession planning to asset protection, investors are encouraged to explore a business entity for real estate to keep their investments protected. Let’s look at a few ways investors could make themselves susceptible to liability without a business entity, putting personal assets in jeopardy:
1. Injuries sustained by tenants or guests- If a tenant or guest(s) of your tenant experiences an injury or accident on your property, you could be subjected to a lawsuit for compensation.
2. Hiring unlicensed contractors- If your tenant hires an unlicensed contractor to make repairs to your property, it could cost you more money for repairs to be done correctly or other fines and fees, especially if an accident/injury occurs due to the improper work completed.
3. Dispute with tenants- If a dispute occurs between you and your tenant(s) over the condition of your property, the lease, or an eviction, without a business entity in place, you could be responsible for fees associated with settling these disputes.
Placing your property in an LLC (Limited Liability Corporation) is the perfect, most cost-effective solution to protect your real estate investment. This type of business entity ensures that investors (company owners or members) are not personally liable for the debts and liabilities of the entity, offering a much-needed layer of protection from these hypothetical situations. Forming an LLC allows investors to separate their personal and business assets and liability as well as obtain an operating agreement.
An operating agreement lets investors open a bank account for their LLC, which they can use to deposit their received rent payments, eliminating the possibility of comingling funds while creating an official business operation for their rental property. Investors who operate their real estate investment under an LLC can manage their properties more professionally and effectively with an aura of anonymity, implementing office policies for late payments and other stipulations they set forth.
Not Hiring a Licensed Real Estate Attorney Could Cost You
It’s common for first time investors to commit oversights when it comes to forming an LLC on their own. Whether it’s skipping out on hiring an attorney to ensure the LLC is created correctly or failing to open a bank account in the name of the LLC and comingling payments, when investors try to cut corners, it can cost them financially. Many investors may believe hiring an attorney for creating an LLC is too costly, but that’s a misconception. Without an expert attorney, investors could lose their asset protection all together, even if they completed some of the steps successfully, resulting in significant losses and liabilities.
For example: If a tenant gets sick on one of the properties owned by an LLC due to mold growth, but the property owner functioned as the handy man for repairs, the bookkeeper, and accepted checks under a personal name, a lawsuit could be brought against the property owner personally, sidestepping the LLC due to improper practices.
Another common mistake investors make who form an LLC on their own is failing to conduct the annual filing. This can result in the state dissolving the business entity altogether, making all signed contracts void, and any filed lawsuits go against the individual property owner. If this is the case, all the assets that the property owner has, whether it’s additional properties, bank accounts, wages, and more, if a judgement is entered against the individual, all assets are in jeopardy. If a lawsuit is brought against an LLC and the LLC was formed correctly, then only the assets owned by the entity would be at risk, not the assets owned by the individual who owns the LLC.
Other complications derived from an improper filing of an LLC arise when attempting to sell the property. While it’s much easier for an investor to purchase a property when first forming an LLC without using a licensed attorney, it becomes much more cumbersome when it’s time to sell the same property and steps were missed. Common issues occur when a title company needs to verify who has the right to sign on behalf of the entity, especially if there are multiple people listed on the LLC. This major dilemma can prevent investors from unloading their properties and is extremely costly to fix.
LLC rules and regulations vary state by state, not by federal laws, so it’s critical to consult with an attorney based on this fact alone. For individuals looking to invest in real estate, the smartest thing investors can do to protect their investments and assets is to hire a licensed real estate attorney to form an LLC for their property(ies).
Choosing the Best Business Entity for Your Real Estate Investment
Not all real estate investors will have the same objectives for their properties, which is why it’s important to understand which business structure is best for your type of investment. From fix and flip to buy and hold, not all real estate ventures are the same, nor are the recommended entities for holding your properties.
For a fix and flip scenario which will see a lot of people through a short-term basis with the goal of unloading the property, it’s recommended to hold all these type of investments under one LLC. For individuals looking to buy and hold properties, it’s suggested to hold each property under a separate business entity, aka series LLC, where the holding company owns the buy and hold properties and the fix and flips LLCs.
Fix and flips should be looked at differently from an investment perspective and set up differently than a buy and hold from a tax perspective as well, which is why speaking with a licensed real estate attorney is the smartest thing an investor can do.
Prepare for Your Family’s Future with Succession Planning
It’s imperative for investors who hold real estate in their LLC to be proactive with their properties to ensure a smooth transfer upon death. Oftentimes, when someone who owns real estate passes away, even if that individual has a will, there will still be probate. To avoid the onerous probate process, it’s suggested to set up a revocable trust (living trust) in which all assets are titled, making the distribution of assets simple.
To avoid filing fees and deeding of properties, individuals who own multiple properties in an LLC can set up a revocable trust so that when they pass away, the membership interest is easily transferred without probate. This type of careful planning can make a difficult time for your family a bit easier, especially when it comes to distributing assets accordingly and mitigating disputes.
Partner with the Pros for Your Next Real Estate Transaction
If you’re searching for a knowledgeable, highly recommended licensed real estate attorney in the Naples, Florida area, contact Jeffrey Grant of Grant, Cottrell & Miller-Myers at (239) 649-4848.
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