Is incorporating neseccary? And if so, when?

Question

Just read chapter four of the UGB. The part I wonder the most about is structuring a business entity. First of all, I'll most likely be getting into real estate by buying a small multi family property. Would it be in my best interest to incorporate( let's say with an LLC)? And if so, would I have to structure the entity right away or could I buy the property as an individual and then incorporate. I'll likely be using an FHA loan and I heard that an LLC can't use an FHA, only an individual. Thoughts?

Account Closed · Answer

There are many different forms of corporations. The traditional corporation is what is traded on the open stock market- anyone can buy shares and their percentage of shares gives the share holder that much voting power. The day to day decisions are made by a board of trustees and the corporation may or may not pay dividends to it's shareholders. The next variation is the closely held corporation, same idea but the shares are sold privately.

For a small business owner, there are three options, LLC, S-corp and C-corp. The obvious advantage is, if you incorporate the corporation becomes its own entity and if for some reason you default on the loan or get sued they can't go after your personal assets- they can only go after the CORPORATION'S assets. You only stand to lose what you personally invested out of pocket. It acts like a shield protecting your assets (your personal house, car, money in the bank, etc.)

S-corp's and C-corp's are a little more complicated in terms of documentation, taxes, etc. C-corp's are subject to double taxation- any profits the corporation makes gets taxed and if you decide to pull money out of the corporation (i.e. pay yourself a dividend) it gets taxed again. An S-corp requires you to pay yourself a 'reasonable salary' so if you're trying to keep yourself under a certain income bracket or something like that this may or may not work for you. An LLC (limited liability corporation) doesn't really change the taxes- you will be taxed the same as a sole proprietorship (just you owning the business) or partnership (if you have a business partner) BUT it still protects your personal assets. Its also simpler in terms of taxes and documentation.

I suggest talking to an accountant and/or tax specialist to see which is the best option for you.

**Here's a fun fact to leave you with- you do not have to incorporate your business in the state in which you live or the state where your business physically exists. Shop around and see which state offers the BEST deal. For example Delaware offers some really good rates. You can incorporate your business in Delaware without ever setting foot there.

Edward B. · Answer

Account Closed,

Definitely talk to some professionals, CPAs and lawyers. It is actually a relatively complicated matter that should not be undertaken lightly. Otherwise, you may incur hundreds or thousands of dollars in costs and not acheive what you want. For example, you can indeed incorporate in any state but you will have to register it in your own state to do business there, i.e. hold rental property. So now you are paying the annual fees in two states. Here's another one. You cannot transfer an FHA loan into an LLC without triggering the due on transfer clause. I have read posts on BP where the investor set up the LLC per recommendations here and then was upset to find out he couldn't transfer his property without risking the loan being called. Then he finds out that loans to an LLC are much more difficult to come by and the rates and terms are not nearly as good, which changes all of your performance projections. Also, with the type of investing you are talking about you will likely have to personally guarantee any loan to the business entitiy so your personal assets will in fact be on the table if you default.

There are many very...very...successful investors on BP that will tell you not to bother with incorporating and to just buy plenty of insurance. Personally, I am not one of them. I believe that if you are going to be doing business you should do it in some form of entity. For your purposes that is typically an LLC. I feel that relying on insurance alone leaves too much to chance, but that is just me. I would rather spend the money on the LLCs. BUT, you need to understand the intricacies involved with doing so or not doing so. Whole books have been written on the topic and thousands of posts on BP address this very decision. Do a little bit of research and then if you are confused on something or have a specific question reach out to the BP community and you will get many very different points of view.

Ed

Account Closed · Answer

Oh. Hundreds *or thousands. Ha ha, that's a big difference.

Account Closed · Answer

Wow. Thanks Ed. I didn't realize it could cost that much. Gives me something to think about. No way I could afford hundreds of thousands.

Account Closed · Answer

Thank you for that detailed explanation.

Account Closed · Answer

Could you elaborate a bit more? I don't quite know what you're saying.

Account Closed · Answer

*Necessary