When setting up your fix and flip business, you need to make some decisions regarding legal structures and how you will take ownership of the properties you buy. Will you own them in your own name, in a corporation, in an LLC, etc.? The answer to this question will have tax, legal, and liability implications for you, and this post certainly cannot replace the advice of your legal and tax advisors; however, we will provide a brief overview of your options.
Owning as an individual. This is the simplest form of ownership and requires the least amount of advance planning – you simply submit the contract in your name and sign the documents at closing. Additionally, your tax returns will be straightforward, as you’ll report all income directly on your personal return. A significant downside, though, is that you will not be shielded from any liability risks associated with the property, such as personal injury and other similar claims.
Owning in a limited liability company. A limited liability company is a relatively simple business entity that can be formed quickly and inexpensively in most states. The basic purpose of a LLC is to provide some level of protection to your personal assets from claims against the LLC. Said another way, in an ideal situation, someone with a claim against the LLC can only attack the assets of the LLC (your investment property) and not your personal assets. There are caveats to this, though, and you must follow certain steps – importantly, be sure to keep accurate records of your company’s finances and maintain accounts (such as bank accounts and credit cards) that are separate and independent from your personal accounts. Commingling money with your personal accounts may provide a creditor with a legal avenue to pierce the protection of the LLC and pursue your personal assets, so it’s vital to keep a clear separation between your personal and business finances.
Filing taxes for an LLCs is relatively simple, and depends somewhat on how many partners (or members) you have. If you are the sole owner of the LLC, you’ll report all income directly on Schedule C or your personal return. If your LLC has multiple members, you can choose from multiple forms of taxation. In the simplest option, the LLC can choose to be taxed as a partnership, meaning that the LLC will file a brief independent tax return and each member’s share of the income (free of any corporate tax) will be reported on a K-1 issued to each member.
- Owning in a corporation. In many ways, corporations can be similar to limited liability companies, though there are some differences. Corporations come in two types: C-corporations and S-corporations. C-corporations are the structures used by large companies, file their own tax returns, and have the distinct disadvantage of being subject to double-taxation (both the corporation and its owners pay taxes on its income), so, for this reason, you likely won’t be using a C-corporation for your investing business. The income from S-corporations, on the other hand, can be passed directly to your personal return, just like a LLC. There are some several minor differences between S-corporations and LLCs, such as the allowable number and types of owners and potential limits on the transferability of ownership, but most of these differences are not relevant to the typical fix and flip investor.
Understanding the differences between these structures, most real estate investors choose to own their properties in an LLC. The ease and simplicity of creating and maintaining an LLC, combined with the liability protection it affords, make it any easy choice for most situations. While forming a new LLC can seem like a formidable task for new investors, it’s really quite simple – below is an outline for getting your new business up and running:
Register your LLC with the State. Find your state’s corporate registration website (this is usually easy to find with a simple web search) and locate the form for registering a new limited liability company. This form is usually no more than 2-3 pages long and requires only basic information. Submit this form along with the filing fee (usually a few hundred dollars at most), and you’ll have a newly formed company!
There are companies available online that will handle the filing and registration of your company on your behalf, if you aren’t comfortable doing this yourself. In exchange for a fee, they’ll handle all of the paperwork with the state. In most states, though, it really is easy to do all of this yourself.
Request an IRS Tax identification number, if necessary. If you will have multiple partners in your company, will have any employees, or will file your company’s taxes as anything other than a disregarded entity, you’ll likely be required to request an employer identification number (EIN) from the IRS. Fortunately, this is free and can be done online in a matter of minutes. Upon completing your application, you’ll receive a letter showing your new EIN – save this for your records and future use.
Draft an Operating Agreement. This can seem like a complex document, but most of it is boilerplate text that can be obtained from many templates easily available online. The key function of this document is to define who owns the company (and in what percentages), who has authority to make management decisions, and any other provisions that may be agreed upon between the members. If your LLC will be a single-member LLC (you’re the sole owner), this document is easy – you’re the sole member and manager. If you’ll have partners, though, you’ll want to closely review and discuss the various provisions.
- Open a Bank Account. As mentioned above, separating your business and personal finances is an important step in preserving the liability protection afforded by the LLC. Before doing your first deal, open a new bank account in your LLC’s name and be sure to transfer money from this account when you buy your first property.
While all of this may seem complicated, it’s really not. With these simple steps, you’ll have formed your real estate business and will be ready to submit your first offer.