Investment properties are a great way to generate extra cash. In this way, they are very similar to brick and mortar businesses. As with any business, you will need some type of legal structure to ensure that everything is on the up and up. But, how do you get started? First of all, it’s not as difficult as you may think. Simply ponder the concepts put forth in this article. They will help you get closer to your goal of financial freedom. If you own one investment property, chances are you don’t need any kind of legal structure. But, if you are interested in growing your portfolio and adding more investments, you should reconsider. At this point, you are essentially a business owner. Taxation and liability are now two of your greatest concerns. The proper legal structure will help you deal with both:
Legal structures explained
Businesses can’t afford to expose themselves to liability and exorbitant taxes. Those looking for an easy way out think that operating as a single proprietorship and filing their income and expenses on their personal tax returns is the right thing to do. But, taking this route isn’t a good idea. To be successful as a business entity, there has to be a buffer between your personal and business assets. If you don’t establish legal safeguards, it can put your personal assets at risk if you fall behind on your debts or are sued. The best way to protect yourself legally is with a documented business structure. Far from being complicated, this is simply legal documentation that will help you protect your business. Furthermore, if you pick the right one, you maintain the freedom to run your business the way you want to.
Here are 4 common legal structures to consider
You are an individual with specific needs and wants. To choose the best legal structure for you, think about your personal goals. Once this is complete, consider which of the following legal structures will help you most:
- C Corp: This legal structure will turn your business into a legitimate corporation that pays its own taxes. The best thing about this option is, there is no limit to the number of owners. This makes it perfect for a group of investors looking to make a large real estate investment. Furthermore, because the company’s earnings have nothing to do with your personal tax returns, there is no income tax liability.
- S Corp: For those looking for tax benefits, this one is an excellent choice. The income that an S corporation generates flows through to the shareholders’ personal tax returns. In this way, the S Corp isn’t responsible for tax-related liabilities.
- Real Estate Investment Trust (REIT): REITs are very secure and efficient but they come with a very big catch. To qualify for this legal structure, you must give your shareholders at least 90% of your annual income. This limits your growth significantly.
- Limited Liability Company (LLC): As the name suggests, these legal structures limit the investor’s liability. So, if you plan to be in the investment game for years into the future, this option may be best for you. It’s perfect for investors who are interested in long-term capital appreciation and a steady income. Furthermore, LLCs are relatively cheap and the forms are simple to fill out. They are simple to manage as well. It’s also important to note that, LLCs are pass-through entities. That is, both losses and earnings are passed through to your personal income tax returns. On one hand, this makes this type of legal structure very easy to manage. On the other hand, you must be very careful not to mix your business and personal expenses. Any deviation will leave you liable.
The Bottom Line
Regardless if you have one property or are planning to own hundred, it’s time to start thinking long-term and set up a legal structure for your business right away. It’s much easier to set up a legal structure from the beginning than it is to grow into it. If you fail to take heed, reincorporation may be in your future. Unfortunately, this process is time-consuming, expensive, and it can do a number on your business. Avoid this altogether and use the tips listed above to help you determine the best plan of action for your particular needs.