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Investing in real estate can be a lucrative business, especially in a high demand area. Though not every investment yields returns, if you can afford the upfront costs of purchasing a property, both short and long-term investment strategies can be profitable.
The term “real estate investors” includes a diverse group. A single person purchasing a “summer home” that she rents in the offseason is a real estate investor, as is someone who buys, fixes and flips several properties per month. What all these people have in common is a need to separate their investments from their personal assets.
Forming a company does just that, but it’s not quite that simple. If you’re investing in real estate, or planning to start, it’s important to understand your options. This post reviews how to determine which state to choose as your home, and why LLCs are the most popular entity among real estate investors.
As with any business formation, you can choose which state in which to file. The most popular choices include Delaware, Wyoming and Nevada. Of course, many investors choose their home state, since they have to pay taxes to that state to operate. However, the three aforementioned states – and Delaware, in particular – offer some great additional benefits.
What sets Delaware apart from other states is its Court of Chancery. Delaware relies on experienced judges (known as chancellors), and not juries, to rule on corporate law cases. This is the primary reason why more than two thirds of Fortune 500 companies are Delaware corporations, not to mention the tens of thousands of other companies file in Delaware each year.
Another benefit of choosing Delaware is that Delaware allows LLCs and corporations to file privately, without the names of the owners on public record. This is ideal for separating yourself from your business operations.
In most cases, an LLC is a simpler solution for real estate investors than a corporation. Some may have a specific reason to choose a corporation (such as a plan to sell equity in the company), but LLCs are popular because they can be filed quickly and easily, while providing a strong layer of protection for its member(s).
It is important to note that while corporations can file privately in Delaware, their first annual report (and each subsequent one) must include the names of its Directors, at which point those names are on public record. This is not true of LLCs, which remain private year after year.
LLCs also typically require less effort to maintain each year. In Delaware, an LLC pays a flat annual tax of $300, regardless of revenue or any other measure of business.
The simplest case is a single-property investor. If you have one rental property in Florida, for example, you can form a Delaware LLC to hold the title of the property. Because the property – and thus the business operations – is in Florida, you will have to obtain Foreign Qualification in Florida to operate your Delaware company there. This involves an application and fee, as well as an annual tax paid to Florida, in addition to the $300 tax for Delaware.
So, why doesn’t a Florida real estate investor just form the company in Florida? The answer is simple: Florida doesn’t provide the same protections, referenced earlier, that a Delaware company provides.
This is not to say that many investors don’t do just that. Indeed, it is not uncommon for an investor to opt for lower upfront and annual costs, rather than the long-term protection of a Delaware company. This decision is essentially a risk assessment – do you choose lower cost and high risk (including the possibility of being sued for everything you own), or higher cost and low risk? Often, the peace of mind is a return on investment in and of itself, not to mention the actual savings if a lawsuit is filed against you.
Multiple properties (especially spanning multiple states) or a combination of rentals and “flip” investments create additional considerations. Your unique situation will dictate your ultimate business structure. Educate yourself on common asset protection strategies for real estate investors, so you can make an educated decision.
To form a Delaware LLC, there is some basic information you need to provide, along with a payment.
While Harvard Business Services specializes in Delaware formations, we will also help you form your LLC in any state. You can view our Delaware formation packages on our website or contact us for help getting started.
All we need to know in order to file your limited liability company (LLC) or corporation in Delaware is:
Once you form you real estate investment LLC, the next step is to create an operating agreement. In Delaware, the operating agreement is not actually filed with the state; it’s just maintained internally within the organization. However, because it does have legal standing, it is imperative that every LLC have a current operating agreement on file.
While we are not lawyers and cannot guide you in creating your specific operating agreement, we do offer free templates that you can use. Just choose the type that suits you.
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE'S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.