When purchasing an investment property, most real estate owners form a holding company or a legal entity designed to provide certain tax advantages and a level of protection from personal liability.
Which entity you choose depends on how you’ll manage your investment and your overall financial goals. To make an informed choice, seek professional counsel from a tax and/or legal advisor.
Sole proprietorships and general partnerships generally offer the least benefit, as the person running the business remains personally accountable for any debts or liabilities. That means if an accident occurs on your property, your personal wealth is at stake.
A limited liability entity, however, provides some key protections. An LLC, Limited Partnership, or S-Corp will shield you from common business liabilities, such as accidental injuries.
A limited liability entity will not protect you from certain debt obligations, because banks will usually require a personal guarantee on the loan. However, that presents a limited level of exposure, as property values do not usually exceed the value of the loan.
Limited liability companies do provide certain tax advantages. With these entities, any income earned on a real estate investment is counted as personal income. By comparison, when real estate is held in a C-Corp, the business is taxed once on the income and then the owners are taxed a second time on any gains.
Meanwhile, real estate held in a limited liability entity could decrease your taxable income. If the property shows a loss (which may be legally calculated through depreciation deductions), your overall tax burden declines even if the property didn’t appear to lose money when a basic income in, expenses out analysis is used.
On the other hand, choosing a C-Corp may provide certain advantages. Because a C-Corp is considered a wholly separate entity, financing arrangements may be streamlined. That’s because lending underwriters can only look at your C-Corp investment, not your personal finances and separate business investments. That may be of particular concern for active investors who hold multiple properties with short-term goals, such as real estate flips.