If you plan on investing in real estate, in particular owning and managing real estate yourself, it may be a good idea to start a real estate investment company. In addition to certain tax advantages, using a holding company to conduct and manage real estate investments can reduce your personal exposure to risk and liability. Learn what the benefits are, and what is involved in starting a company to determine if it’s the right move for you.
What is a real estate investment company?
A real estate investment company, often referred to as a holding company, is a legal entity that is designed specifically for business activity, including holding investment properties. A limited liability company (LLC) is the most common structure for real estate holdings, but there are alternatives. These include an LLC with S-Corp designation, limited partnership, sole proprietorship, or corporation (C-Corp). It’s uncommon for real estate investors to file as a C-Corp because they are subject to taxation twice -- once at a shareholder level and again at a corporate level.
A real estate investment company owns and manages any investment(s) and separates properties held by the company from personal holdings. It essentially acts as a shelter that provides protection from personal liability. If your LLC owns three separate rental properties, each property can be managed individually, but all taxes, income, or losses will be shared within the LLC.
Benefits of starting a real estate investment company
Real estate investment companies are a popular choice for investors because of the numerous advantages they offer in terms of taxation and asset protection. A holding company:
- Keeps investment properties separate from personal holdings, limiting personal liability and exposure.
- Prevents double taxation on investment properties.
- Offers specific tax benefits and deductions such as the pass-through deduction.
- Offers flexibility in profit distribution in order to gain maximum tax benefits.
Investing in real estate opens the door to potential liability and litigation associated with owning property. For example, litigation can arise if someone is injured on the property. If the property is held in your name and you as the owner are found responsible, you could be personally liable for the costs.
Conversely, if the property is held in a holding company and the company is found responsible, it is the entity itself that would be liable, not the individual managing the company. It is important to note that if a company owns multiple assets, any assets held within that company could be exposed in the event of litigation. This is why many real estate investors have multiple companies in order to properly protect each individual asset.
Asset protection is one of the largest benefits of starting a real estate investment company. But there are also several tax advantages available to those who operate using a pass-through entity, such as an LLC, S-Corp, limited partnership, or sole proprietorship. Any profits generated by the company are passed through the business to the individual, who then files an individual tax return. If the business is structured correctly, real estate investors are able to capitalize on the multiple tax benefits available and avoid double taxation.
Drawbacks of starting a real estate investment company
The biggest drawback of creating a real estate investment company is the upfront and ongoing cost of maintaining the company. There is, of course, the initial cost to start the company and the annual fees to renew and keep the company in good standing. Additionally, someone will need to prepare and file taxes, which can range from a few hundred dollars to a few thousand depending on the amount of activity that was conducted. For some, the cost doesn't support the benefits.
Another drawback is record keeping. There are specific documents such as annual meeting minutes and other forms that are reviewed, signed, and maintained each year. For many, this is an annoying extra task and can easily be missed after starting a company.
Speak with a licensed professional
As previously discussed, there are a variety of ways to structure a real estate investment company, such as an LLC, limited partnership, or corporation -- although corporations are rarely used for real estate holdings. In addition, there are designations that can be made such as filing your LLC as a C-Corp, S-Corp, or sole proprietorship, which is typically elected as a tax strategy.
Before starting a real estate company, it’s advised that you speak with an experienced licensed professional such as an accountant that is well versed in real estate tax law. A knowledgeable accountant can advise you on which structure is best for you based on the type of investments you plan to hold.