I get asked multiple times a day if someone should buy real estate in a LLC or an individual name.
A simple question, that unfortunately deserves a complicated answer.
The first thing from my biased (as a banker) point of view is you need to decide what kind of loan you want and capital structure you desire before you think about what kind of borrowing legal structure.
For instance, a lot of first time real estate investors want a fixed-rate 30-year loan. This is a typical personal mortgage and these mortgages cannot be made to LLC’s or other legal entities. These mortgages are only allowed to be made to individuals in their names.
If you would like to buy a property in a LLC or other legal entity you will need a commercial loan which typically amortizes over 20-years and is only fixed for a 3 to 5 year window.
Therefore, you need to decide what is more important, growing a real estate company with a certain entity and the legal protection, or a longer-term fixed rate.
One important point is that you can get a commercial loan in an individual name. You might ask, why people do that? The answer, is that it is typically a lot easier to get a commercial loan because you have a relationship with a bank and/or banker and they don’t typically sell these loans off.
Ok, with all this here is a review of the ownership structures and the positives and negatives with each:
Contents
Individual Ownership
Buying a property in your individual name is not only the most common way to buy real estate but also the simplest. The challenge is you can only have a certain number of mortgages in your personal name. Do your own homework about how many mortgages because the number changes.
Partnerships
Partnerships are very easy to set-up usually just requiring a simple legal document and filing with the state. However, like anything they can quickly become complicated and not offer the legal protection you thought you had. A lot of hedge funds have a simple General Partnership (GPs) that manages the fund and Limited Partners (LPs) that invest their capital in the fund.
Limited Liability Corporations
LLCs are extremely popular because they are fairly easy to set-up and have easy pass though tax implications. A big benefit is you can allow unlimited number of business partners.
Corporations
This type of entity is not common for real estate because there is essentially a double-tax as the company pay’s its own taxes then pays out a dividend on after-tax money. Then you pay taxes on that dividend income.
These are very popular for holding companies that own several different companies underneath them and are publicly traded.
Sub-Chapter S corporations are extremely popular and work identical to a LLC, with one exception. That exception is S-Corps are only allowed 99 investors. I personally use S-Corps because in my state the filing fee’s with the state are significantly less than a LLC and I never plan on having more than 99 investors.
Trusts
Trusts are a popular way to own property so people can’t figure out who owns it. They are also very easy to transfer ownership to other family members without tax implications. When you sell a property, you can transfer any interest with an “Assignment of Beneficial Interest” document.
Real Estate Investment Trusts (REITs)
Most people think REITs are just for big publicly traded real estate companies. However, most REITs are non-publicly traded REITs. To classify as a REIT you must pay-out 90% of your income. This avoids the double taxation of typical corporations.
The obvious disadvantage is it’s very hard to grow because you are paying out the vast majority of your earnings. This is one reason why most REITs are highly leveraged. They are using debt to grow earnings and equity.
https://www.irs.gov/pub/irs-pdf/i1120rei.pdf
Action Points!
I HIGHLY RECOMMEND YOU TALK TO A LAWYER ABOUT THIS ISSUE! There are not only legal implications with what kind of entity you buy real estate in but tax implications as well.
Talk with your spouse, business partners and other stakeholders about what legal entity they prefer.
In summary, also note that the vast majority of professional real estate investors use a combination of these legal entities to fit the funding profile and risk of each investment.
If you are a first-time real estate investor be sure to check-out this infographic:
https://realestatefinancehq.com/dont-buy-home-without-reading-infographic/