October 17th, 2016

As a tax advisor, one of the most common questions I get from investors is “what type of legal entity should I hold my real estate in?” Unfortunately, you may have guessed that the correct answer to this question is most likely “It Depends”. For real estate investors, the best legal entity to hold title to your investment properties should accomplish the following 5 objectives:

  1. Minimize taxes due to the IRS and State agencies and in turn result in a higher overall return on investment
  2. Allow for maximum asset protection against potential lawsuits and creditors
  3. Provide privacy to the owner(s) of the property
  4. Allow the investors to achieve a wide range of flexibility and options regarding the management and control of the property,
  5. Minimize the complexity and cost of maintaining the legal entity(s).

You may have heard people tell you “Always use LLCs for real estate”, and another person may say “Always hold your real estate in a Trust”. As a real estate investor, it can be both confusing and frustrating to receive such definitive, yet contradictory advice. As a result, a lot of investors are left to wonder – just which one is correct?

Well, the answer again is: It Depends! Unfortunately, in our complex tax code, there is no “easy way” to provide an answer. Also, there is no “one size fits all” strategy that works for all real estate investors. An analogy I often make is:  Giving out tax advice without first understanding everything about the taxpayer is the same as a doctor prescribing medication without first doing a diagnosis.  In both the financial and medical field, this is known as malpractice. Every taxpayer is different and unique. As such, the BEST legal entity(s) to hold title to your real estate investments will depend on your personal, business, investing, and overall tax situations.

Here are a few examples of things I analyze when working with investors to determine the ideal entity structure for their real estate holdings:

  1. What type of property will be purchased? (Commercial, multifamily, single family, office space, etc.)
  2. What is the length of the expected holding period of the property?  (Long-term hold, fix and flip, wholesale, etc.)
  3. What is the projected monthly/annual income for the next several years? What are the types of income to be earned? (Rents, management fees, commissions, vending income, etc.)
  4. What are the investor’s exit strategies for the property?  (Sale, lease option, seller financing, 1031 exchange, transfer to next generation, etc.), **TIP** – YOU SHOULD ALWAYS HAVE MORE THAN ONE!
  5. Last but not least, what other types of income or investments is the investor involved in? (This includes a review outside of the real estate and analyzes the taxpayer’s tax situation as a whole.)

The answers to all of the questions above will assist you in determining the optimal legal entity structure for your investment. It is true that an LLC can be a great entity for those investing in real estate. But there are times when holding your investments in an LLC will result in significantly higher taxes vs. in a Corporation or a Trust.  In order to identify the ideal entity structure for your real estate holdings, here are the action steps to help you get started:

Step One: Spend some time and think about your answers to the 5 planning questions above.

Step Two: Seek out your qualified real estate and asset protection attorney to help you develop the best entity structure for your real estate holdings from a LEGAL perspective based on your answers above.

Step Three: Concurrent with Step Two, seek out a tax advisor to help you develop a strategy to determine the best entity structure for your real estate holdings from a TAX perspective based on your answers above.

Step Four: Develop the optimum entity structure for your proposed real estate investments using the guidance of both your legal and tax advisors. Get them to work together as a team to develop the best strategy and structure for your situation.

Most investors spend time and resources on research, due diligence, rehab, leasing, and property management to ensure the profitability of their investments.  Make sure you take that extra step to determine the best legal entity to hold your real estate and further increase your return with significant tax savings.