Investing in real estate with your own cash can only take you so far. Utilizing private funding can help you access larger deals or grow your portfolio at a faster rate. But this can also put you at risk of commingling funds if not properly understood beforehand. If you plan to borrow money from multiple sources for a real estate transaction, learn what commingling real estate is, if it's legal, and what rules investors should follow.
What does commingling in real estate mean?
Commingling real estate is when money pooled from multiple investors is mixed, or commingled, with personal funds or the money of others. This could be in the form of mixing and managing multiple real estate transactions and properties from one bank account, or using funds from one investor or investment account to pay for expenses or costs related to another.
Is commingling legal?
Commingling in general is legal and actually more common than you may think. Business partners who contribute their own personal funds into a joint account for the benefit of the creation or management of the business is a commingled fund. A couple who enters into a marriage with one party owning a property prior to marriage, but both partners pay for the mortgage out of a joint bank account, is commingling funds.
A real estate investment trust (REIT), crowdfunding investment, mutual fund, and pension fund are all additional examples of a commingled fund, in which a fiduciary or investment manager invests money from multiple clients into a particular fund or group of investments at a time. In these examples, the fiduciary has the right to commingle the funds for the benefit of the client. Buying larger amounts of an investment at a given time can result in lower trading costs or better pricing depending on the asset.
However, if the fiduciary or investor who pooled money mixes the funds with their own money or with others without authorization to do so, it's illegal, as it breaches their fiduciary duty. The contract between the two parties should state if commingling is prohibited. For a real estate transaction, commingling is prohibited, meaning it's illegal for the investor to mix funds from one pooled investment with the funds from a separate property or their own.
How to avoid commingling in real estate
Before you continue reading, I want to emphasize that I'm not a lawyer. I work with licensed attorneys who specialize in raising capital for real estate and syndicating property to help keep me compliant and suggest you do the same. I am not giving legal advice but sharing some basics about raising capital and using funds from investors to buy real estate.
If you plan to pool money for a specific property or group of investments, there's a good chance the investment will be deemed a security, requiring you to file certain regulations with the Securities and Exchange Commission (SEC) to do so legally. There are different structures investors can choose from to legally pool funds, such as creating an investment fund or having one offering for each individual property purchased with a limited liability corporation (LLC) or as a trust and held in a separate trust account.
But no matter what path you take, make sure to keep the pooled money separate from your personal funds and other investment funds. Don't use your business account to pay for personal things, including frequently transferring money to and from your personal or bank accounts, without a proper paper trail. While you can sort this out by refunding the account afterward or coding the transaction accurately in your bookkeeping software, it can become a bad habit that if uncorrected could be defined as commingling.
While it may not be necessary to have a separate account for each investment property, you should make sure the money doesn't commingle with your general business accounts or personal accounts. You may want to create a new bank account for each property or have the funds placed into a dedicated escrow account or trust account managed by a third-party escrow agent to add a layer of security and protection.
It's also important to keep good records. Proper bookkeeping records showing deposits and payments made to or from the account should be able to disprove any claims for commingled money. Commingling funds pierces the corporate veil and opens the door to litigation, putting your investments and money at risk in the event mismanagement of funds is brought into question or under the scrutiny of an IRS audit.
The Millionacres bottom line
Following the rules above from the start as you establish your business will mean you reduce your liability exposure when working with investors.