What is the best legal entity to obtain for flipping houses in FL?

Question

Hi Everyone!I am new to the home flipping industry in Tampa Bay and am seeking feedback on which type of business entity I should pursue. I am obviously looking to maximize my coverages and protection, while minimize my taxation. I have a partner, and a CPA suggested either going with an LLC or a Limited Partnership, which is the path on which we are already headed. My partner is looking to have his personal assets out of the reach of any third parties. I know LLCs and LPs pass through taxable income and loss, thus avoiding the double tax on income that is inflicted upon corporations, and owners of LLCs and LPs can claim the losses on their tax returns. An advantage of LLCs, is that the owners may claim tax losses in excess of their investments, such as on certain leveraged real estate investments. Any further insights/advice/reasons to go one way or another? I appreciate any feedback. Thanks,Jon

Brandon Hall · Answer

@Jonathan DragoSorry, I should have clarified - an LP would have a limited partner and a general partner. An LLP will not have general partners. The investor who wants to remain out of reach may consider forming his/her own LLC and then having the LLC invest in your entity. When an LLC elects S status, its operating agreement and other documents must conform to the S corporation eligibility requirements. If, for example, the LLC’s operating agreement allows special allocations of income or loss to be passed through to members, the LLC is not eligible to be treated as an S corporation because it would be considered to have more than one class of stock. (An S corporation has one class of stock only if all outstanding shares confer identical rights to distribution and liquidation proceeds. Differences in voting rights are ignored.) Allocations based on anything other than percentage of ownership breach the one-class-of-stock rule and are not allowable in an S corporation.S corporation shareholders must be of the same class, except for the ability to hold voting and nonvoting shares. The operating agreement of an LLC operating as a partnership, on the other hand, might specify that certain members are general partners and that others are limited partners. The IRS has ruled that the general and limited partnership interests that confer identical rights to distribution and liquidation proceeds satisfy the one-class-of-stock requirement. However, the IRS will not issue advance letter rulings on whether state-law limited partnerships that check the box to be taxed as corporations have more than one class of stock (Rev. Proc. 2013-3, §5.01(18)).

Brandon Hall · Answer

@Jonathan DragoIf your CPA suggested an LLP, I'd strongly suggest getting a new, real estate savvy CPA. Not to mention that the majority of states only allow professional service providors to utilize the LLP structure. @Wayne Brooks is correct in that generally, you will want to set up an LLC and elect sub chapter S (S-Corp) as your taxation structure. This election will help you minimize self-employment tax liability.

Wayne Brooks · Answer

LLC, taxed a s a SubS, to help avoid/recude self employment-SS/Med taxes.

Jonathan Drago · Answer

Hi Brandon, in regards to filing my LLC, should I list myself as AMBR, and my investor as a MGR? Remember, he will be providing the capital for our investments and wants to have no liability, and I will be running the company and making final decisions. I am not sure if I should be listing him, or not listing him within my entity at all, as you recommend him starting his own LLC and investing in mine. He will be receiving a percentage of our revenue (per deal), so how would that work if I'll be filing Sub S, if he is receiving a portion of the revenue. Would you mind elaborating? I appreciate your feedback and advice.Thanks!Jon@Brandon Hall

Jonathan Drago · Answer

@Roberta James Thanks for the comment. Yes, I'm joining a couple of organizations to better my networking in the area. Hopefully we'll be able to meet up soon!

Roberta James · Answer

This is great insight for me as well since I am just starting out as an investor the Tampa Bay Area too. @Jonathan Drago, have you considered joining a local meet-up group in your area? I just joined North Tampa Bay Real Estate Investors Association group and have learned so much in so little time. I'm placing my first phone call to a motivated seller today just from the encouragement well received from my peers. I'm hoping to land at least 2 deals before year end. Keep me posted to your success as networking is a powerful thing in our industry. My partner and I have access to buying houses with cash as well as buyers and sellers lists. If you are looking for a buyer or a seller, there's a good chance we can do business. Best wishes and successful deals ahead!!

Brandon Hall · Answer

@Jonathan DragoThat's more of a legal question, however your investor will not need to elect S status as his income will be considered passive vs. active.

Jonathan Drago · Answer

@Brandon Hall, thanks for elaborating.OK so to recap, you're saying that for my situation of having an equity investor that wants to remain out of reach, I should create an LLC, and elect sub chapter S (S-corp) as my taxation structure as there are only two of us, and I will be the lead for the company. My business partner should also create a separate LLC and then have that LLC invest in mine. Should my partner set up the same taxation structure (sub S) for their LLC?...Once again, I appreciate all the help!

Jonathan Drago · Answer

@Wayne Brooks, @Brandon Hall, thanks for the feedback! I believe the reason I was given the discussion on LP, is that my partner does not want to have any liability from 3rd parties. Were they wrong to say that with LPs, I would be considered the general partner with all liability? I'll have to check on FL's laws regarding the LLP entity and professional service providers.LLC seemed like the way to go. Does that make sense with an equity investor that wants to be passive and out of reach?