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What To Consider When Choosing A Legal Entity For Your Real Estate Business

By RealtyBiz News | April 21, 2023
Group of business people collaborating in office
Group of business people collaborating on project in office

Legal entities are the structures real estate companies use to own and manage their businesses. These entities include sole proprietorship, partnership, and limited liability. Real estate investment trusts (REITs) and corporations are other typical real estate legal entities; your company can adopt any of them. 

However, it helps to consider a few essential things to ensure you're picking one that suits your property management and ownership style. This article lists what you should consider when choosing a legal entity for your real estate business:

  1. Legal Requirements

Your real estate business must meet its recordkeeping and reporting requirements, including filing annual reports with the state and maintaining accurate financial records. It's vital to consider such legal requirements when choosing your legal entity. 

These requirements may determine if you need a registered agent to do all the paperwork and provide service. You may wonder, 'can I be my own registered agent?' In the case of LLCs, which includes handling paperwork and documentation from the federal government, it's possible.

The same can be true for sole proprietorships. However, you can encounter a few hurdles with corporate legal entities in some states. Some states may also make it more difficult for partnerships and REITs regarding requirements. It's essential to consider the ease of carrying out such documentation when selecting a legal entity for your real estate business.

  1. Liability Protection

Every business owner forms a legal entity for a valid reason—to protect their personal assets from their business's liability. Corporations and LLCs should be your go-to options if that's your case. Meanwhile, limited partnerships (LPs) and limited liability partnerships (LLP) can offer liability protection. They’re also better than REITS and sole proprietorships.

In the face of financial uncertainty, your worst nightmare can be losing your personal property to foot the debts. Your mortgage lender may also initiate legal proceedings for foreclosure if you default on your loan, causing financial strain. 

It's best to avoid losing everything. Therefore, choose an ideal legal entity that lets you pay off debts and loans without sacrificing your personal properties. 

  1. Tax Implications

Your chosen legal entity's tax implications determine how much profit you'd make on your real estate business. Tax implications are the financial consequences directly impacting your tax obligations, usually from your real estate transactions. 

For example, corporations are usually taxed, and their shareholders get tax cuts on dividends. The opposite is true for sole proprietorships and limited liability companies (LLCs), which are pass-through.

The type of legal entity you choose for your real estate business determines tax rates, deductions, and compliance costs. LLCs and sole proprietorships are on the lead in helping your business save more on these aspects. Limited partnerships and S Corporations can also help you with tax liabilities due to their high flexibility in management and taxation.

  1. Capital Raising

If you plan to raise capital for your real estate business, it's best to consider legal entities to facilitate the process. While every legal entity can help you achieve that, not all are equally efficient. 

For example, LLCs have a much-limited ability to help you raise capital compared to corporations. Even though you can issue membership interests to investors, you can structure your capital as debt or equity under LLC. 

Conversely, corporations can help you quickly raise capital by issuing stock to investors through a private placement or initial public offering (IPO). LPs and REITs may also have that ability, but they're only the same as LLCs in their limitations. It's best to have a proper acquaintance with an ideal legal entity if your primary aim is to facilitate capital raising.

  1. Management Structure

Flexibility in management can be your primary desire in your real estate business, and it helps to select a legal entity that facilitates it. Some legal entities may require that you have a fleet of management personnel, starting from you as the owner, a board of directors, and officers. Hence,  you can only make pivotal decisions if you consult them, and their presence can only heighten operation costs.

If the latter doesn't sit right with you, LLCs should be your ideal legal entity as they offer more management flexibility. REITs, sole proprietorships, and general partnerships can also help manage your business flexibly. On the other hand, corporations may frustrate you to the core. You may find it fit to avoid them if management flexibility is your primary aim.

Conclusion

Choosing the appropriate legal entity for your real estate business depends on how you want it structured and how you want to manage it. You must consult your legal advisor when selecting a legal entity. Choosing the most suitable one can shape your business operations and outcomes, including your profits and progress.

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