Note business legal structure

[Patrick Snoke]

I am undecided on the best legal structure to invest in notes as a side business. I have 3 options and each has their own things to consider. I have personal investment fund and an IRA of equal value

1. Sole proprietor/DBA- Easy setup, pass through to my personal taxes, can use the cash management account in my brokerage account to warehouse/invest between opportunities. Downside is liability and I would need to do a separate self directed IRA to tap additional funds that can't be coming led with personal.

2. LLC- Easy setup, no double taxation/personal tax pass through, increased liability protection. Downside is another tax return to have completed (minor) and I still can't use IRA funds with personal. Can't have single brokerage/cash management account for stocks/note investing funds.

3. C Corp & use a ROBS (roll over business startup)- Expensive setup and yearly costs but unlocks my IRA funds to create one large pool of capital. Double taxation issue as well. ROBS need to be an operating business rather than an asset holding company. I feel like this would be a great option if I were to quit my job to invest, but that isn't likely.

It almost seems like the LLC is the obvious answer, but I would really like to find a way to have one large pool of capital for stocks and note investing in a single checking/trading account. Maybe I can't have it all.

Do most note investors use an LLC or in their own name/DBA?

If I were to add rental properties to the mix, does that change things?

What is the best solution?

[Dave Van Horn]

Hi @Patrick Snoke,

I tend to agree with you, I like option number 2.

For my note investments, I prefer to utilize a Delaware LLC because of the state's favorable corporate and banking laws (there are also other states that offer similar advantages). The LLC offers you the personal tax pass through that you mentioned above and gives you a little extra liability protection.

To Bill's point, there is certainly a difference between being in the note "business" and owning the assets as an investor. I personally have two entities that aren't in the note "business" (in terms of originating or modifying mortgages), the entities merely own the assets as an investment and the notes themselves are serviced by a licensed servicer. Keep in mind laws vary, for example, I know some states require a license to be a debt buyer or debt owner - but many of these states have exemptions of course (i.e. certain states may allow you to own up to 5 notes for example without this type of license).

Now another viable option is owning notes in a trust, which I also like because it gives you anonymity and gets you out of the public record. You can buy and own notes in your own trust, but you could also add a layer of additional protection by creating a trust where the trustee is an LLC.

A Self-Directed Retirement Account is another type of trust that can own notes. These accounts can even form and own an LLC that takes title to notes for an extra layer of protection on behalf of the IRA account holder. This strategy can give you more checkbook control and save you money on IRA custodian fees as well.

No matter what I wouldn't recommend owning notes in a C Corp (why choose double taxation?) or in your own name (why take on more personal liability?). As for your other question about holding one flexible account for multiple types of investments, I have to ask: are you at a truly self directed IRA custodian? These types of places are usually pretty flexible, allowing you to invest in the market and notes in the same account.

Although, when it comes to investing with different sources of capital (retirement money vs. personal), I don't believe you can co-mingle the funds into a single account. But the good news is, you can invest in the same investment that takes money from both sources as long as the investment asset is titled with the correct percentages tied to each source of capital (i.e. 50/50, 60/40, etc).

Best,

Dave

p.s.

I'm schedule to appear on the NoteMBA podcast this week, so stay tuned!