062: Let’s Get Legal: The Ins and Outs of Real Estate Holding Companies
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Real estate holding companies have recently become all the rage amongst passive investors for many reasons we will discuss in today’s episode. A common question we get is if they’re worth it and if people should start one of their own.
What we can tell you is, real estate holding companies have become a time-honored tradition of today’s most prolific entrepreneurs– and this could also include you.
If there was a guarantee that everyone you loved would never be hurt or face another obstacle again– you would jump on that opportunity, right? In a similar fashion, real estate companies are one of the few vehicles capable of protecting entrepreneurs both from themselves and the malicious intents of others. ✨
While we love the sound of that, a large concern of starting a real estate holding company is the intimidation factor, especially for first-time passive investors.
This is where things get legal. ⚖️ You know, like where lawyers get involved and various documents with your signature are filed. A holding company is a legal foundation on which your entire company will be built on.
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.
This is the Cashflow Multipliers Team we’re talking about, they can handle anything.
I know! For all you passive investors listening, embracing the many advantages a holding company can provide might outweigh the burden of starting one. So let’s get into it, what is a real estate holding company? 🤔🤔
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. You also might know them by their more common name, limited liability companies, or an LLC.
LLCs do not participate in business operations themselves but own different assets. The purpose of this structure is to prevent business owners from being personally responsible for debts or other liabilities incurred by the entity, thus the name “limited liability.” 💡
So basically, your LLC is what’s between you and the bus that could potentially hit you and cause serious injury. You’re protected by your LLC and don’t have to worry about your personal gains taking a beating should anything happen to your business. 🤓🤓
LLCs have been around since the 1970s, but real estate investors have recently taken advantage of its many benefits only in the last decade. They are now often used as a tool to reduce personal exposure to monetary and legal risks.
Again, this is all about protection. Passive investors, think of the amount of money you invest– knowing there is a barrier between you and the many variables that could go wrong, a holding company can only help you, not harm you. Plus, there are significant tax benefits, and it’s way easier to manage compared to other legal entities. 😁😁
We’re telling you this because we care about your business, and most importantly, you. While real estate holding companies are not the only way to protect a business and/or your investment through apartment syndication, most investors find the benefits to be the most accommodating.
So… Do I Need a Holding Company?
So, would The Kitti Sisters recommend a real estate holding company for you? Our answer probably won’t surprise you, but, it depends!
We can tell you from experience that people who invest with us passively mainly invest as individuals or via their real estate holding company /LLC. 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 business liability, and it’s also smart to keep your real estate income separate from your personal income. 😉😉
Keeping your personal finances separate from your business finances is always a wise decision, and we know many of you high-level investors are already on track following this method. Holding companies are relatively inexpensive to start and the benefits largely outweigh the cost and upkeep to maintain them. 👌
Honestly, it’s worth getting one just for the peace of mind alone. Now, also keep in mind you wouldn’t use an LLC to purchase a home as your primary residence, usually, a property like that is tied to you as an individual– not a company because the bank wants you to sign as a personal guarantor on the loan…
Maybe you’re one of our house-flipping followers or commercial real estate guru, in that case, those niches in real estate can really benefit from a holding company.
Investors may also benefit from an LLC, as it can provide additional legal protections. At the end of today’s podcast, we want you to have a deeper understanding of real estate holding companies, LLCs, and how they can affect your overall business strategy and investments. Take comfort in knowing you’re already taking the right step, just by tuning in!
What’s the Tax Catch? 🧐🧐
We talk a lot about taxes with our Cashflow Multipliers Team, and for good reason! Taxes and real estate go hand-in-hand. Holding companies are no different and they too pay taxes, though they can vary depending on the organizational structure.
Let’s say you are the sole proprietor of a holding company, this means the entity itself is not required to file with the IRS, and instead, you are responsible to report all profits (or losses) in the tax paperwork.
On the other hand, a two-person LLC will be treated as a partnership. This means each owner will be responsible for paying taxes on their share of the returns. Of course, this is where things can get a little messy, so first and foremost make sure you have the right partner (easier said than done, we know) and consult a tax professional before moving forward with this step.
The Holding Company Structure
Did you know anyone can be a CEO? You just need to know where to file the paperwork and appoint yourself as head honcho. 😲😲
But then comes the work, you need to know how to operate this LLC you just started.
Generally speaking, the holding company’s structure will look something like the holding company or LLC at the top, and individual subsidiaries exist underneath it. You’re familiar with the manager-employee relationship, but in this case, 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. 👀👀
Good parents are the ultimate protectors, right? Let that mentality sink into your business model. Let’s get into even more reasons why an LLC is beneficial to your business.
Need More Reasons to Start a Holding Company? Here are a Few
There are plenty of benefits associated with starting an LLC that go beyond taxes and ease of administration. Real estate investors can gain access to unique benefits and enhance the long-term health of their businesses. Here are some other key benefits an LLC offers to your real estate assets.
- Holding companies can protect passive investors from liabilities.
- A holding company prevents double taxation on investment properties.
- The business structure allows investors to easily manage their properties.
- As a whole, LLCs pay fewer fees when compared to corporations.
- Holding companies provide passive investors with more flexibility to distribute their profits.
- Holding companies are more easily transferrable than other entity types.
Keeps your Cards Close
Let’s get vulnerable for a sec. Investing in real estate is lucrative and passive. Traditionally, there is a lot of money involved in every investment opportunity. And with all your money out on the table, you have no choice but to keep your cards close.
This is why it is absolutely imperative for passive investors to protect their personal finances. Wearing your heart on your sleeve can be a beautiful thing, but in matters of business, protecting yourself, and ultimately your family, this is a necessity— not an option.
LLCs limit personal vulnerability to potential lawsuits related to the property, which is perhaps the most intriguing aspect of starting a holding company.
Pass-Through Taxation
If that’s not enough reason to convince you, maybe pass-through taxation will be. In fact, some passive investors consider framing their business structure like an LLC based solely on tax benefits. Liability protection may simply be only a bonus to some.
Nothing sounds worse than doubling your taxes, right? In 1988 a court ruling enabled real estate investors to avoid double taxation if they acquired properties through an LLC. Thankfully, the IRS views it this way too and classifies a real estate holding company to have one owner in the same way they would see an individual owning one piece of property– otherwise commonly referred to as a “disregarded entity.”
In doing so, any income and capital gains generated by the business would passthrough to the owner, who, as a result, will only have to pay taxes as an individual. However, the owner still enjoys protection against any liability.
It’s the best of both worlds!
Business owners are in a desirable position to avoid double taxation because no separate tax is required to form your LLC. Neither the rental income generated by a property nor the appreciation in value upon disposition results in tax penalties. Additionally, the owner 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.
Fewer taxes and more in deductions. Through the magic of three letters word– LLC.
Now for the folks who are considering an LLC where more than one person is involved. 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.
Without sounding like those cheesy law commercials, whether you’re a single-member or multimember LLC, you are entitled to compensation and pass-through taxation benefits. As a reminder, this is in addition to the liability protection we talked about earlier.
Talk LLC Benefits to me, Baby
With the rise of passive investing through apartment syndication, people have become wiser about the benefits of real estate holding companies. However, there is more to this designation than meets the eye.
I almost feel like we’re selling credit cards with all of these perks we’re discussing but, without further ado here are some even more reasons to go for that LLC.
Let’s do it!
- Ease Of Management: What if we told you LLCs are kinda like hippies? The structure presented by an LLC makes delegating management responsibilities and positions a lot easier. Corporations can be too stuffy with directors and officers, LLCs are free to roam and 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. Check to see what fees your state might have you incur.
- Flexibility: LLCs award real estate investors the ability to exercise incredible flexibility during profit distribution. Unlike an S Corporation, an LLC member can financially reward the “sweat equity” put forth by a specific individual.
- Versatility: Unlike 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. Something to keep in mind for your future heirs.
Ready, Set, Start Your Holding Company
By this point, we hope you’re excited about the future of your LLC, and the many benefits it can offer and protect you from. But now the question still lingers, where do you start?
Here’s the good news, it’s not as complicated as it may seem. For our Cashflow Multipliers Team, we’ve broken down a step-by-step guide to starting a real estate investment company. First up, choose your real estate holding company name, next is file the Articles of Organization.
Then, create an Operating Agreement and publish your intent to file. And finally, obtain required licenses and permits.
You Have a Holding Company, Now What?
You’re well on your way to being in a league of your own with other top investors who have taken the holding company route. Trust us, you’re in good company!
And speaking of company, now that you have your company, you may be wondering what to do next. It’s all about being organized, which will help protect your business in more ways than you couple possibly imagine. Taking steps such as
- Obtaining an Employee Identification Number (EIN)
- Getting your business license and permits
- Opening a separate bank account
- And applying for a business credit card will help the longevity and overall health of your holding company.
LL-Me
You don’t need us to remind you that as a real estate investor, there are risks in this industry. We don’t want to sound like a negative right Palm?
Whoa! Personal!
As a real estate investor, there are risks in this industry. There is no way we can promise 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. Just think of this as your Elle Woods era. A little legal work can pay off big time to keep your assets safe, and you simply can’t put a price on your peace of mind.
There are plenty of investors who choose to not go through the LLC route, and that’s completely a viable option.
➡️ Personally, we created an LLC that protects our assets from other liabilities. This means our passive investors feel secure and protected when they choose to invest with us.
We can see why real estate holding companies have risen in popularity as passive investing through apartment syndication has grown in the past decade. We know different investors have their own take on the subject, but we’re big believers in protecting what we have worked so hard to build.
Paying a fee to license your business and protect your assets is a small price to pay compared to what you have to lose. We’re happy to keep this information available and ready to understand so you’re living your best, most financially free life! 😉😉
As always, we’re here for you! So follow us on Instagram, @thekittisisters, and check out our website, thekittisisters.com if you haven’t already and listen to previous podcasts, check out some free resources, and learn how to invest alongside us!
Until next time, Cashflow Multipliers Team💋‼️
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