Business Entity Options
Real estate investors can benefit tremendously from the formation of a business entity such as an s-corporation, limited liability company, and special purpose entity.
S-corporations are best for short term investors. For example, fix-and-flip real estate investors. Fix-and-flip real estate projects have grown exponentially in popularity. These investors are acquiring a distressed property with the intention of improving and stabilizing the property to sell it for a profit.
Why should short term real estate investors form an s-corporation?
An individual investing in real estate with a fix-and-flip strategy will have to deal with a self-employment and social security tax rate on their profit. However, if the individual forms an s-corporation, the investor will be able to avoid a percentage of the self-employment and social security tax rate.
Short term real estate investors specializing in fix-and-flip projects are considered dealers, not investors. Therefore, this puts them at a disadvantage when tax season comes around as they can’t take advantage of certain tax benefits such as the 1031 exchange, depreciation, and lower capital gain tax rates.
Limited Liability Company (LLC)
Limited liability companies are best for long term investors. For example, real estate investors with a buy and hold strategy aiming to accumulate numerous streams of rental income with long term asset appreciation. The ownership of real estate does not establish the exchange of business in most states.
Why should short term real estate investors form a limited liability company?
Long term investors can use a limited liability company to decrease personal liability, risk exposure, reap the benefits of pass-through taxation, simplifies the process of investing with partners, separates your business operations from personal operations, acquire properties anonymously, tax benefits, and finance deals easily.
Single Purpose Entity (SPE)
A single purpose entity (SPE) is a borrowing entity which has no other assets or liabilities aside from those which it is being formed to acquire. Lenders who are providing financing for large real estate portfolios and/or commercial real estate transactions typically require the borrowing team forms a single purpose entity?
Why do lenders prefer investors form a single purpose entity?
Lenders prefer the formation of a single purpose entity as it decreases their risk exposure to the borrowers’ assets and liabilities which the lender isn’t providing financing. Single purpose entities limit the lenders risk exposure as real estate investors often have numerous loans and project going on at the same time.