How To Start A Real Estate Holding Company

Starting a real estate holding company has become a time-honored tradition of today’s most prolific entrepreneurs. If for nothing else, there are few vehicles capable of protecting a new business owner both from themselves and the malicious intents of others.

Truth be told, a real estate holding company can be intimidating to first-time business owners, and for good reason. A holding is the legal foundation on which your entire company will be built. It is worth noting, however, that starting one is not as daunting as it may seem. Yes, it is integral to the start of a business, but that doesn’t mean you should be intimidated. Instead, investors should mind due diligence and embrace the many advantages a holding company can provide.

What Is A Real Estate Holding Company?

A real estate holding company is a legal entity designed to protect business owners from the risks that come with owning investment properties. Real estate holding companies, also known as limited liability companies (or LLCs), do not participate in business operations themselves but own different assets. The purpose of this structure is to essentially prevent business owners from being personally responsible for debts or other liabilities incurred by the entity, thus the name “limited liability.”

Although the enactment of LLCs can be traced back to the 1970s, real estate investors have largely begun to take an interest in the past decade’s benefits. They are now often used as a tool to reduce personal exposure to monetary and legal risk. Through a holding company, owning investment properties is also known to create significant tax benefits, and ease of administration when compared to other legal entities.

While real estate holding companies are not the only way to protect a business, most investors find the benefits to be the most accommodating. In other words, if you want to learn how to start your own business, it could not hurt to look into forming one for your protection.

Who Needs A Real Estate Holding Company?

A real estate holding company is typically a great choice for short-term and long-term investors. Any real estate investor can benefit from protecting their personal assets from any business liability, and it’s also smart to keep your real estate income separate from your personal income. Holding companies are relatively inexpensive to start, and the benefits generally outweigh the cost and upkeep to maintain them. Note that you do not need to start an LLC if you’re just purchasing a home as your primary residence.

Do Holding Companies Pay Taxes?

Holding companies do pay taxes, though they can vary slightly depending on the organizational structure. For example, a holding company with one business owner will typically be treated as a sole proprietorship. This means the entity itself is not required to file with the IRS, and instead, owners will need to report all profits (or losses) in their tax paperwork. A two-person LLC, on the other hand, will be treated as a partnership. This means each owner will be responsible for paying taxes on their share of the returns. For more specific information on how a holding company is taxed, be sure to consult a professional with any questions.

Holding Company Structure

Generally speaking, the holding company’s structure will look something like this: the holding company or LLC is at the top, and individual subsidiaries exist underneath it. For real estate, the subsidiaries will typically be investment properties. The holding company itself will not have a hand in day to day operations of each property but will instead serve as a parent company. There are several benefits to utilizing this structure, which we will discuss below.

Real Estate Holding Company Example

An example real estate holding company may help illustrate what this business structure would look like. In this example, I want to start Business Holding Company, LLC. After I follow the necessary protocol (filing with the state, paying fees, etc.) I decide to purchase an investment property. The property will be owned under Business Holding Company, LLC, with a property manager in charge of operations.

Let’s say I purchased an apartment complex before starting Business Holding Company, LLC. In this case study, I now want to move that property into my newly formed LLC. To do so, I would obtain a deed, file the necessary paperwork, and then transfer the property ownership. I would also update any documents that need to reflect the change in ownership, like tenant agreements and leases.

Now, I have two properties operating under Business Holding Company, LLC. The holding company’s balance sheet would then reflect the combined operating income, liabilities, and ROI. As an owner, I would be responsible for oversight and support. While this is an oversimplified example, it can serve as an overview of what a real estate holding company might look like.

Why Start A Real Estate Holding Company?

Setting up a real estate holding company has become increasingly popular in the last decade, and for good reason. By incorporating their businesses, real estate investors can gain access to unique benefits and enhance the long-term health of their businesses. Real estate holding company benefits include, but are not limited to, the protection of investors from personal liability, pass-through taxation, and the building of credit for your business.

• Holding companies can protect business owners from liabilities and debts incurred by their properties.
• A holding company prevents double taxation on investment properties.
• The business structure allows investors to more easily manage their properties.
• As a whole, LLCs pay less fees when compared to corporations.
• Holding companies provide investors with more flexibility to distribute their profits.
• Real estate investment company enables investors to purchase properties in the U.S. and abroad.
• A holding company is more easily transferrable than other entity types.

Furthermore, those wondering how to set up a real estate holding company will be pleased to find out that they are relatively easy to register. The sections below will expand upon each of the main benefits, along with some of the lesser-known perks.

Limits Personal Vulnerability

Investing in real estate is a rather lucrative career choice. There is traditionally a lot of money involved in every deal—at least more than the average individual can cover on their own accord. Having said that, it is absolutely imperative for respective investors to protect their personal finances (those outside of their business finances). First and foremost, LLCs limit personal vulnerability to potential lawsuits related to the property, which is perhaps the most intriguing aspect of starting a holding company.

Any lawsuit against an LLC is aimed specifically at the company, not the individual responsible for it. If an LLC owned the property in question, the owner’s risk exposure would be insulated by the company’s protection, leaving only the assets owned by the LLC (as opposed to all of the owner’s assets) exposed to potential lawsuits. In other words, personal finances would not be in jeopardy.

Pass-Through Taxation

Assuming liability coverage is the most important factor in forming a real estate holding company, taxes are a close second. In fact, some real estate investors consider framing their business structure as an LLC based solely on tax benefits. Liability protection may be a bonus to some.

A 1988 court ruling enabled real estate investors to avoid double taxation by acquiring property through LLCs. As defined by the default tax classification rules, the Internal Revenue Service (IRS) classifies a real estate holding company with one owner, in the same way they would a sole proprietorship, otherwise more commonly referred to as a “disregarded entity.” Accordingly, any income and capital gains generated by the business would transcend to the owner, who, as a result, would only have to pay taxes as an individual. However, the respective owner still enjoys protection against liability. It is the best of both worlds.

Seeing as how there is no separate tax accompanying the formation of an LLC, business owners are in a position to avoid double taxation. Neither the rental income generated by a property nor the appreciation in value upon disposition incurs tax penalties. Additionally, the owners of a single-member LLC can use mortgage interest as a deduction around tax time. In forming an LLC, you are not only subjected to fewer taxes, but you are awarded more deductions.

However, real estate companies owned by more than one person are viewed differently in the eyes of the IRS. Otherwise known as “multimember” LLCs, these business entities are taxed similarly to a partnership. Multimember LLCs also enjoy the benefits of pass-through taxation as the LLC passes its profits and losses through to its members. Each respective owner is then responsible for reporting their share of the profits (or losses) on either a Schedule C, K, or Form 1065 with their individual income tax returns.

As the owner of a real estate holding company, single-member or multimember, you are entitled to pass-through taxation benefits. Again, all of these tax benefits are in addition to the liability protection shield that was previously discussed.

Additional LLC Benefits

Real estate holding companies came to prominence approximately 10 years ago, as real estate investors were made privy to the upsides they offer. However, there is more to this designation than meets the eye. Real estate holding companies are relative to other legal entities that, while not unique, apply to the use of LLCs when holding real estate assets. Those perks include, but are not limited to the following:

• Ease Of Management:The structure presented by an LLC makes delegating management responsibilities and positions a lot easier. Whereas a corporation is statutorily required to have officers and directors, LLCs are free to be managed by their owners, or even a third-party.
• Cost:There are a lot of states that impose additional fees on the authorized number of shares a company has. While LLCs are still subject to these fees, they may pay less than corporations. State registration and maintenance fees are therefore lower for businesses structured under an LLC.
• Flexibility:LLCs award real estate investors the ability to exercise incredible flexibility during profit distribution. Unlike that of an S Corporation, LLCs do not have to be pro-rata (in proportion) in the distribution of cash flow. In other words, an LLC member can financially reward the “sweat equity” put forth by a specific individual.
• Versatility:Unlike that of an S Corp, LLCs promote foreign ownership and investment in U.S. real estate.
• Transferable:The structure of a holding company makes it easy for anyone to transfer ownership. Real estate holdings can be “gifted” to heirs each year without actually going through the process of signing a deed. In fact, gifting property allows owners to avoid certain taxes.

How To Start A Real Estate Holding Company

Starting a real estate holding company is not as complicated as it may seem. Investors can familiarize themselves with the process and get started today. Here is a step by step guide to starting a real estate investment company:

1. Choose a business name:First and foremost, you will want to research your state’s rules on setting up an LLC, such as through this guide provided by the U.S. Small Business Administration. The first step is selecting a business name, which will always be followed by a comma and the letters “LLC.” Make sure to run a search to make sure that your desired business name is not already taken.
2. File the “Articles of Organization”:Once the business name and business address are determined, a document entitled the “Articles of Organization” must be filed with your state’s LLC office typically the Secretary of State. The document is often available as a simple, fillable form found on the Secretary of State website, along with submission instructions. Once prepared, the document can be submitted by mail or in-person with a filing fee.
3. Create an Operating Agreement:An operating agreement outlines the roles and responsibilities of each member of an LLC. This document does not need to be formally filed with the state, but it should document how the business will be organized and run internally. An operating agreement may include the method of choosing managers, rights and duties of members, ownership and operation rules, voting procedures, members’ percentage interests, and how profits or losses are distributed.
4. Publish your intent to file:Although required only by a few states, find out whether or not you are required to publish an intent to file through your local newspaper. Otherwise, your LLC is considered officially formed once your Article of Organization are accepted and approved by your Secretary of State.
5. Obtain required licenses and permits:Once your business has officially been set up, you can take your process a step further by obtaining any business licenses and permits that might be required. Also, do not forget to apply for a tax identification number through the IRS for your new business.

Summary

As a real estate investor, you should be aware that your particular industry is prone to risk. Without sounding too negative, there is simply no way to eliminate all risks associated with starting a real estate investment company. However, with the right education and legal designation, you can effectively mitigate a great deal of risk. Accordingly, complying with the formalities set forth by an LLC will protect your business from many threats.

After having gone over the basics, you now are equipped with an understanding of the benefits of starting a real estate holding company, how they compare to other legal entities and the difference between an LLC and liability insurance, and which option is best for your business. Once you have decided that setting up a real estate holding company is right for you, be sure to review the general steps, and your business will be up and running (and protected) in no time.