Real Estate Investment Companies

How Do You Setup Real Estate Investment Companies?

Creation depends on your tax, assets, liability and personal preferences. Our clients often inquire about creating real estate investment companies. Should they form a LLC to conduct all of their real estate business? Should they form different LLCs? Do they need a separate company at all? How do they obtain mortgages as a LLC or another corporate entity? Does it matter if they are doing different activities (for example, flipping and property management) within the same company?

Our answer to these questions usually depends on three factors:

1. Tax Savings. How do you minimize your tax footprint and pay Uncle Sam the least?Assets & Liabilities.

2. What is the extent and value of your assets, and how do you minimize your overall exposure to liability?

3. Preference / Factual Setting. How complex or simple will your overall organization be? Do you have different partners for different aspects of your business? Do you envision selling different aspects of your business at different times?

Tax savings, in general, can and should be addressed by your CPA. Don’t make a decision about corporate structure without consulting with one first. When talking to your CPA, keep in mind two things: First, closely held companies with similar ownership structures (i.e. a parent that owns 80% or more of the voting and value of one or more subsidiaries) can submit a consolidated tax return. Second, when your accountant says “S-Corporation,” he or she is referring to the tax status of the corporate entity, not the entity type itself. LLCs can be taxed as a S-Corporation, and should be given serious consideration as such.

To reduce liability, consider a separate LLC for each significant asset. Liability should be compartmentalized as much as possible. If you’re a doctor who owns some real estate and the building your practice operates out of, you should seriously consider a LLC for your practice, and separate LLCs for each real estate holding. The reason for this, is if you are sued for medical malpractice, and the damages (or legal fees) pierce your malpractice insurance, the properties cannot be touched (because they are owned by separate LLCs). Likewise, if someone (heaven forbid) gets hurt or killed in a fire in one of your properties, the exposure is limited to the LLC that owns that property, not any of the properties owned by other LLCs nor your practice nor personal assets.

Contrast the above example against an entrepreneur doing business with all his real estate holdings owned by one LLC. If one property experiences a mishap, the LLC is liable for the harms and therefore all real estate holdings owned by that LLC become at risk. If that entrepreneur has all his assets owned by that one LLC, all his assets are at risk. Similarly, suppose your real estate investment company includes some construction, property ownership and property management, and your construct business experiences a mishap whereby a contractor negligently causes a fire that burns down adjacent structures. That one mishap, for a relatively low-value business, then exposes any and all assets and property owned by that LLC.

What’s worse, general liability insurance generally does NOT cover intentional acts of a company. If a contractor or employee goes postal, or a mishap occurs in the line of duty that turns out to be classified as an intentional act, your insurance will not cover you. How can this occur? Suppose one of the workers digs without calling or seeking a permit first, and causes a gas rupture (this happens more often than you might think). Therefore, as a general rule, we recommend one LLC for each major holding, whether a property, business, practice or other significant asset.

Consider an Umbrella LLC

Umbrella companies can provide significant estate planning benefits. Different LLCs (or companies) can help you vary ownership, depending on the structure of a particular deal. For example, consider a dental practice with multiple partners. Each partner in that practice could share ownership in the practice’s LLC, while whomever owns the building the practice is operating in, can benefit with a different ownership structure than the practice itself. Or, one of the dentists could own an “umbrella LLC” that itself owns a portion of the dental practice, with his or her family sharing ownership in the umbrella LLC for estate planning purposes.

Parting Thoughts

Know what “commingling” is, and make sure you don’t do it. As you consider how to expand your business(es) and how to leverage corporate entities, please make sure you seek the advice of counsel and a good CPA.

Also, think about the following: Mortgages. Many individuals can only obtain a mortgage by obtaining it in their own name, and do so only to later change the purpose or title of the property while keeping the original mortgage. Unfortunately, this is generally against most mortgage policies, and if a bank or lender wanted to press the issue, the mortgagor could call the loan. Many mortgages will permit a change in the title (i.e. because this happens regularly due to divorce, for example), which would allow you to migrate a personal residence into a LLC. Many banks will provide personal mortgages for “investment properties,” although they may come with a slightly higher rate than you will find on mortgages for primary residences.

Commingling & Piercing the Corporate Veil. “Piercing the Corporate Veil” is used in litigation in an attempt to go after the personal assets of the owners of an LLC or corporation, and is generally hard to prove. The general legal theory behind this is the “alter-ego theory,” that states the owner and the corporation (or LLC) are really one and the same, and to prove this, plaintiffs usually attempt to show that an owner is not following the corporate formalities (i.e. observing the bylaws or operating agreement) or the owner is commingling funds, assets or resources (i.e. employees, space, etc). For example, if all your LLCs are located in the same space, but the LLCs don’t pay their fair-share of rent can trigger a commingling issue. There are other factors a court may consider.

When you have multiple LLCs, seek advice from an attorney to ensure your business practices don’t trigger a factor that could allow the court to remove the liability protection a LLC or corporation offers.

Call today to schedule a free consultation with our Hawaii real estate attorneys: 808-465-2500