What’s the Best Corporate Entity for a Real Estate Investment Business?

Perhaps you’ve been a real estate investor for decades and you’re working within an older corporate structure. Or maybe you’re a newer investor and want to learn what kind of corporation makes the most sense for your business. Or maybe you don’t have any interest in setting up any kind of formal corporate structure and want to do business under your own name. Whatever your unique situation might be, the kind of corporation you set up – or don’t set up – will have a huge impact on how much money you end up sticking in your bank account at the end of the day.

Recently a couple of successful real estate professionals, one a seasoned transactional real estate attorney and the other a very successful real estate investor, put their heads together and discussed the pros and cons of various corporate structures specifically for the real estate investing business. It turns out the best corporate entity varies depending on what you want to accomplish with your business. Here are a few corporate options to consider.

-Limited Liability Corporations (LLC)

An LLC is a legal entity that provides the same limited liability as a corporation with the tax benefits of a partnership. Many investors like working within LLCs for some very good reasons:

1. Liability protection – The LLC gives the owner personal liability protection. For example, in most states if you form an LLC and run it as a separate business concern you’re afforded the protection of a C Corporation. Meaning the owner/investor is going to be protected from any claim or personal liability that results from the day to day running of the business, and any business conducted or transactions performed on behalf of that company.

2. Tax benefits and streamlined operation – LLCs provide the legal protections of corporations but are taxed as though they were sole proprietorships. Another advantage of LLCs is they provide you with a lot of flexibility in operating your company. The laws for LLCs are newer, whereas C Corporations often deal with archaic business models that were being used in the 50′s or even earlier.

3. An LLC will give you the flexibility to structure your company similar to a partnership, but give you the liability protection. And by working with an accountant you can realize a lot of tax benefits.

4. Flexibility – The LLC gives you the freedom to run your company as though you were running it personally as an individual, but it gives you liability protection.

C Corporations (C Corps)

The C Corporation is the corporate structure most commonly used, especially by larger companies. However, these days many real estate pros consider the C Corp an unsatisfactory corporate entity for a real estate investment company for a number of reasons, although there are some positives as well. Here are some pros and cons:

1. Double Taxation – With C Corporations you are paying taxes twice. C Corps are taxed separately from the company’s owners, as opposed to an S Corporation which typically isn’t separately taxed. After the C Corp is taxed, any money that then goes out to shareholders, either as a dividend or a draw, must be claimed as income by the shareholder and is taxed as such. So essentially the owners are paying a tax twice.

2. Old stockholder laws – In a C Corporation, the owners are considered stockholders. Shares of stock are issued to the owners when the corporation is formed. When you deal with this kind of stock there are a lot of old laws to which you must adhere.

3. Issues when selling property – If you hold property for a long time in a C Corporation, like a rental property, it may be harder to sell than if it’s in another kind of entity.

4. Lots of paperwork – Usually there are annual corporate filing requirements which vary by state. Sometimes these can be a paperwork headache without professional help.

5. Reinvestment advantage – While the double taxation issue noted above is a drawback, a C Corporation provides the ability to reinvest profits in the business at a lower tax rate.

S Corporations (S Corps)

S Corporations are standard corporations which elect, for tax purposes, to pass income and losses through to its shareholders. S Corps combine the legal setup of a C Corp with a tax structure similar to a partnership.

1. Tax benefits – The income, tax credits, and deductions of an S Corp pass through to shareholders on an annual basis. Meaning income is taxed at the shareholder level instead of the corporate level. The IRS treats the S Corp as a pass-through entity. So you have the S Corp election, and income that is earned by the corporation passes through to the shareholders directly, thus taking out one of the taxes that occur with a C Corp.

2. Officer’s salaries dilute corporate income – In an S Corp, the officers have to take a salary, so they get a W-2 every year. Anything the owners take as a salary is going to dilute from the net income on the profit and loss statement, which reduces the amount of income for the business to be taxed. You’re paying an employment tax. You want your salary to be consistent with 40 to 50% of what the business is earning. If you do that, you can avoid that self-employment tax.

3. K-1 and W-2 forms – The owners of an S Corp get a K-1 form which reveals profit and loss for their share of the business. They also get a W-2 it they’re taking a salary. The K-1 is for the profits and W-2 for the salary. A K-1 form is issued when the S Corp has more than one member. If you’re a single member you can file a C-1 to your 1040. A K-1 is distributed when there are partners. The salaries are deducted from the net income of the business before the K-1 is issued, so the tax liability of the K-1 is reduced by the salaries paid to the owners.

Sole Ownerships

A sole ownership, also called a sole proprietorship, is a business owned by one person. In this type of setup there is no legal distinction between the business and the owner. The owner controls all the assets, but is legally responsible for all debts and other liabilities.

1. Owner has total control – The owner gets all the profits from the business (less any taxes owed) and has total control of the business, including the responsibility for any debts and losses.

2. Difficult to raise private capital – When it comes to raising private money to fund your business, the government – whether it’s the federal SEC or your state SEC – wants you to raise money via a corporation rather than as a sole ownership-d/b/a. So the federal SEC and the state securities offices, when they issue rulings regarding in-trust state offerings and federal offerings, don’t want you to raise money in your own name. They want you to raise money through a legally established corporation. Meaning all your registrations – whether it’s notice filings, a state offering where your state wants to be advised that you’re raising money in that state or doing business in that state, on an intra-state offering or the federal SEC on a federal filing – need to be done under a corporation. You have to establish an LLC or a corporation within which you raise money.

3. Difficult to buy property – For the same reasons The federal SEC and state SECs want you to buy property through a legally recognized corporation and not through a d/b/a or sole ownership. They know that buying and selling property is your business, and should operate under the structure of a corporation.

The takeaway

Deciding on which type of corporate entity to use for your real estate investing company is one of the most important business decisions you can make, so it’s a good idea to consider your options very carefully. The consensus of the two real estate professionals noted above seemed to favor the LLC, but you should make up your own mind after careful consideration of your goals.

Buying Platinum Jewelry As an Investment

Investing in a precious metal like platinum can be a good long-term hedge against the volatility of the stock market, and there are many ways to invest in it. One of the best ways is to buy jewelry made from pure platinum. This allows you to hold a valuable commodity as well as wear a beautiful piece of jewelry – sort of like having your cake and eating it too!

Here are some great reasons to buy platinum jewelry as an investment:

  • The strength of platinum allows jewelers to make quite intricate, yet extremely durable, pieces without mixing in other metals. Thus, you can have a piece that is practical both as jewelry and as a bullion-type investment.
  • Platinum is about 30 times more rare than gold, yet is usually valued in the same general price range. Since it is so rare and so useful, many people believe that platinum could drastically increase in value in the coming years.
  • Platinum is stronger and more durable than either silver or white gold, and is impervious to rust or tarnish, and so is a great alternative to these metals as jewelry.
  • Platinum is important in the auto industry, for use in anti-pollution devices. As environmental regulations get stricter over the years, the value of platinum should continue to rise. And as emerging markets like China and India continue their explosive growth (car sales in China grew by more than 50% in 2009), the demand for platinum will continue to grow as well. All these factors point to a steady increase in the value of platinum jewelry in the coming years.

Financing Your Business With Vendors

Vendors are critical partners having the ability to seriously help or hinder your business. A good relationship with a vendor will help with cash flow, assist in quality service with your customers, and help you reduce the struggles of managing inventory. A bad relationship with a vendor can cause several headaches including seriously hurting the lifeblood of your business, your cash flow. Most business buyers never consider partnering with their vendors to finance their purchase. Here are a few ideas on how to work with vendors in financing a new acquisition.

1. Extend your terms – If you purchase a business that has a heavy need to work with vendors you maybe able to get your vendors to extend your terms after your acquisition. This can allow your business the ability to free up critical cash flow. Don’t be fooled into thinking that an increase in cash flow will pay for you acquisition. It may help with the temporary lull in business that naturally occurs after the change on ownership. One of my students got a primary vendor to extend his terms from net 30 to a one year, no payment no interest relationship. This worked well for my student and the vendor had established a relationship that can potentially last a lifetime.

2. Sharing a letter of credit – Depending on what type of vendor you have (and your relationship with them) occasionally vendors will be willing to extend or share a letter of credit with a client to help them. For example, a construction company that needs materials such as granite countertops maybe able to go to a granite wholesaler and in lieu of a profit they could share a portion of their letter of credit to finance a portion of the construction. Obviously the vendor would be compensated by future business and a spread on the letter of credit.

3. Trade services for materials or like-kind services- A general contractor could offer to trade services for materials. A grocery store could share space for warehousing with a food supplier in lieu of product. The possibilities are endless.

4. Equity investors – Vendors frequently become squeamish of investing in clients because there can be a change in the perception of the relationship. I think that this can be a perfect marriage between two businesses if it is done correctly and with consideration. For example, a struggling business has past due debt to a smaller vendor. A new party could acquire the business and share a portion of the stock in the company to resolve the past due debt. Vendors are not in the habit of investing in their clients; however there can be a time and a place where it is necessary for the survival of all parties.

5. Leaseback strategies- This is a strategy you can use with equipment vendors. An existing business owns $200,000 in equipment. You sell the equipment to the equipment vendor and in turn leaseback to you. Consequently you free up cash to assist in your business purchase.