What Business Organization is Best for Real Estate Investment

What Business Organization is Best for Real Estate Investment

Most real estate investors are looking for reliable tax shelters and ways to maximize their investment profits. In many cases this is achievable through choosing the right business organization through which the real estate investment activity operates. Today we are going to look at several options and present you with the pros and cons of each, so that you can decide what business organization is best for real estate investment in your unique scenario.

Sole Proprietorship

The most common business structure many real estate investors use is sole proprietorship. The profits and losses from an investment made through sole proprietorship are reported on the person’s individual tax return and subject to taxation on the tax bracket they fall in, the maximum of which, under the new tax plan is 39.6%. The main benefits from operating as such structure when investing in real estate are:

  • Simple management.
  • No conflicts of interest.
  • Easier to liquidate the entire estate and not just a fraction of it.

However, there are also downfalls when using this type of business organization. These are:

  • The owner is liable for all debts.
  • The owner may also be liable for personal injury sustained on the property.
  • The property is a subject to liens for other debts.

Partnerships

Partnerships are another type of business organizations that are commonly used for real estate investment. There are different forms of partnerships that represents different kinds of ownership. One is tenancy-in-common and another is joint tenancy. They both have the same liability and taxation features as a sole proprietorship, however, there are more people involved in the management and therefore, decision-making process.

Tenancy-in-common has at least two people as owners and that affects the share of ownership, as well as the rights of survivorship. The shares in this structure can be unequal and if one of the owners passes away their interest becomes part of their estate. This sort of ownership is often preferred by couples who are not married because it is easily created.

In a joint tenancy, the shares of ownership are equal and the surviving partner owns the whole property.

The main downfalls of these general partnerships are that:

  • All partners are liable for the losses.
  • Their personal assets are exposed to a potential loss cover.
  • All parties must agree on all management and sales decisions.

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Limited Partnerships

Limited Partnerships are often classified as the best option for a business organization when it comes to real estate investment. This is because they provide many favorable features on asset protection and taxation. This type of partnerships have at least one general partner and at least one limited partner. Here are the pros in more detail:

  • Limited partners have limited liability, they are only liable for debts to the extent of their investment.
  • Limited partners are allowed to pass-through the losses of the investment on their individual tax return, offsetting a good amount of income taxes.
  • This structure allows the maximum use of depreciation as a tax advantage.

The main negative feature of limited partnerships falls on the general partner, who is often the developer. They need to assume liability for debt of the entire partnership.

Corporations

Corporations are large business entities and usually involve many investors who become shareholders in the corporation. One very important fact you need to know about these business organizations is that they are entities of the state and are chartered by it. Therefore, the rules and regulations of every corporation are outlined in the chater and are different in each state. The main benefits of using this structure for real estate investment are:

  • The shareholders are separated from the entity and in an event of a loss, they only lose their investment.
  • The shareholders are not liable for the debts of the corporation.
  • Any profits from reinvestment are taxed at the capital gain rate.
  • Corporations are allowed to shelter their own income.

We must say that there are also some disadvantages that you should consider carefully.

  • Double taxation is possible if a smart tax planning strategy is not in place.
  • There’s a fee of $500 to $1000 for setting up a charter and annual maintenance fees are also involved.
  • All policies and decisions have to approved by the directors and shareholders may not get a vote unless they are also directors.
  • Losses and depreciation allowances can’t be passed on to the real estate investors.

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Real Estate Investment Trusts (REITs)

This business organization sounds perfect for real estate investors because profits from investment in such a structure are not a subject to corporate tax. However, for this to be true, the REIT must meet a set of requirements:

  • The REIT has to have at least 100 shareholders and no more than 50% of the shares can be owned by 5 people.
  • 90% of the income must come from passive investment and 75% of the income must be derived from real estate investment.
  • The REIT must be managed by trustees.
  • At least 75% of the assets of the REIT must be in real estate, cash and government securities. If there is an investment in any corporation, it must not exceed 5%.
  • Gains from the sale of real estate that has been held for less than 4 years cannot exceed 30% of the REIT’s income.
  • At least 90% of the REIT’s taxable income has to be distributed to the shareholders annually.

Although generally REITs can be a very good business organization for real estate investment, they have these three main downfalls:

  • Quite inflexible structures.
  • Vulnerable to high interests.
  • Tax shelter benefits are very limited.

A REIT could work very well for you and your real estate investment if you put the right tax planning in place. A professional tax expert can help you with that.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intended for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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Fulton Abraham Sánchez, CPA I am Certified Public Accountant, specialized in Tax Planning & Offshore Strategies for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution. You can email me fa@fascpaconsultants.com and follow us on Facebook : FAS CPA & Consultants.

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