By: Tim Randle
Also, this article is not going to discuss land trusts,which some of you may have just stumbled upon. Aland trust is not an entity. Although it is frequently usedin conjunction with entities, it is merely a paper deviceused to shield property ownership from the public.
When I first got going, the recurring wisdom was that aninvestor should use a C corp for cash deals. By cashdeals, I mean anything that throws off cash quickly. Itmight be a wholesale flip, retail assignment, rehab andretail, option, etc.
There were numerous reasons why this was and isrecommended. First, the C corp offers great liabilityprotection and allows the owner to take advantage offringe benefits, thus draining the corp of excess profitsthrough legitimate expenses.
What I've learned the hard way is that this entity is notnecessarily better for cash deals than other entitiesunless you're doing serious cash numbers. By this Imean that the added benefits that a C corp offers arenot available to you without a ton of cash coming in.
Stop and think about it for a moment. Are you going togenerate enough cash to pay normal operating expenseslike salary, marketing, funding, overhead, etc. and stillhave cash remaining to set up company programs forretirement, medical, insurance, education, etc.?
Typically, the answer's going to be "No", at least duringthe formative years. The primary downside to a C corpis that any losses, paper or otherwise, do not flow throughto your personal tax return. You don't get to use themanytime soon.
When I started, the secondary recommendation for cashdeals was an S corp because it did offer many of the samebenefits as a C corp, yet allowed the owner to flow lossesthrough to the personal tax return. Once the business wasthriving then converting to a C corp was not difficult.
When I went through this research again about a yearago, the majority of responses I received was that I shoulduse a Limited Partnership (LP) for cash deals with a LimitedLiability Company (LLC) as the General Partner (GP). I'vealso heard others suggest using an S corp as the GP. Otherrecommendations included using an LLC by itself as thecash deal entity.
What about entities for the keepers? By that I mean anyproperty that hangs around for a while and doesn't cashout soon. It could be a rental, lease option, or any propertywith owner financing, including subject to (Sub2). What Iwas told there was the same; that an LP with an LLC asthe GP was currently best.
The point here is that if you do spend the necessary timeto research this issue (and you should), you are likely toget each of these responses and possibly more.
My experience is that any of these suggested entities isbetter than starting with a C corp as I did. Factors thatshould play into your decision process include setup costsand any state-specific laws for each of the entities. Forexample, in my state, Texas, the LLC is much cheaper toset up than an LP. However, the LLC is also subject tofranchise taxes on gross receipts over 150k and the LPis not.
Confused? I agree it's not easy to know what the rightcourse of action is. Do you need an entity or multiple entities established before you do some deals? Absolutelynot. Why go to the trouble of setting up companies for abusiness that you may decide to discontinue? How do youknow if you'll even like real estate investing until after you'vedone some deals? Why do you need to set up seriousasset protection until you have something worth protecting?
My recommendation would be to begin to research thevarious entities for your state as you continue to workyour investing business. In my opinion there's no needto make things complicated in the initial stages. If there'sno obvious negatives to an LLC in your state, then perhapsthat would be a good start.
I would not rush out and set up a separate entity for cashdeals and a separate entity for keepers as I did. I wouldnot set up an LP as my first entity as it involves at leasttwo partners, one limited partner and one generalpartner. Entities are not set in stone. With the properguidance and counsel from good attorneys and CPA's,you can make changes to your business plans as thebusiness grows.
Again, this is not something you have to figure out whenjust starting. Find someone very knowledgeable about realestate investing, like John Hyre mentioned above, andbegin to ask the tough questions so you can makeinformed decisions. As your business grows, your assetprotection can grow with it.
Thanks for reading. Until next time, good investing.
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