Protect Your Assets with a Real Estate Holding Company

As a business owner, you put yourself in a position of risk. Whether that is your business failing, risk of theft, or general risk that someone may become injured while on your property. Most business owners have a general insurance plan to mitigate these risks and cover these claims, but if you own your property, or work in the field of owning rental properties, there is another method of mitigating risks: forming a real estate holding company.

Real estate holding companies or real estate LLC’s are designed to reduce personal exposure of an investor (property) to anticipated risks and liabilities. The company not only helps in simplifying taxes and bookkeeping but also isolating income from a property or specific properties. This is why most investors are advised to start with their own real estate holding companies.

Owning a property comes with its risks coupled with a possibility of loss and liability that impact the personal net worth. For investors looking to own real estate for doing business, forming a real estate holding company can minimize such risks and impact.

Holding companies are commonly used in real estate to separate assets from liabilities, minimize taxes and provide anonymity. These benefits are not available, or are available to a lesser extent, through forming a single company.

Sole proprietorships do not enjoy the above benefits. They place your business and personal assets at risk, and generally pay higher taxes.

For that reason, at minimum, we suggest forming at least one Limited Liability Company or a Corporation to hold your real estate. Generally, though, forming a real estate holding company and subsidiaries is the best course of action for the serious investor.

There are many ways to structure real estate holdings and we cover some below. Follow the respective sections to additional pages which offer more in-depth accounts.

Property is an inherently risky asset. Tenants can be hurt, contractors can sue, and we live in a litigious society. An aggressive creditor can work to make your life miserable and use the court system as a form of blackmail if you own property in your personal name. The argument will be you are personally liable for any issues, and thus your personal assets are fair game.

Forming an LLC or Corporation avoids this because each enjoy the corporate veil. The corporate veil is the separation of your personal assets and any assets held in the business. If the company is sued, then only its assets can be pursued. There is a firewall, the corporate veil, which prevents your personal assets from a judgement.

Companies also enjoy additional tax benefits that are not available to individuals or those only using DBAs/Trade Names. These tax benefits often offset any formation costs, with the provided asset protection being “free” so to speak.

A single company protects personal assets from business creditors, but it cannot protect business assets from business creditors. For that, additional structuring is needed.

A holding company comes into play if you own multiple properties, or want to aggressively protect a single company, e.g. via equity stripping.

Ideally, each property should be held by its own company. This prevents a problem with one property from affecting other properties you own. Each company acts as its own island, immune from the problems of others. These are called the children companies as they are owned by a parent or “master” company. Sister-Sister setups are discussed in more detail below.

Fortunately, only the parent company has to file a tax return. This is referred to as a consolidated filing and it ensures your paperwork does not needlessly multiply as your holdings do.

Note, those with low or no equity properties may find a holding company for real estate is not necessary. There is relatively little at risk and the properties are not a great target for “fortune hunters” looking to sue. A single operating company may be sufficient in such cases.

Because real estate is a business with a lot of risks, investors typically want to separate their assets and liabilities. This is done through the formation of holding companies and subsidiaries. Real estate holding companies allow you to maintain liability protection for each individual business or investment.

The sole purpose of making a Real Estate Holding Company is to own real estate. The holding company is formed to execute a contract for sale and the deed in its name. In case one seeks financing, they need to pledge the mortgage under the name of the real estate holding company.

As mentioned, the holding company offers protection to the personal assets against the liability of owning real estate as an investment. On the other hand, it also provides tax benefits for the properties and keeps the property’s finance separated from the personal finances.

Tax Incentives

In some cases, a holding company may file a consolidated tax return. In this case the losses incurred in a subsidiary can be offset against the profits of the other subsidiaries. The net ends up resulting in a lower tax bill overall. Typically subsidiaries pay dividends to the holding company, but without creating a tax liability.

Liability Protection

Primarily, a real estate holding company helps to protect your personal assets, as well as your primary business assets. If someone were to get hurt in one of your businesses, that person can sue the owner. By having a holding company as the owner, you avoid personal liability, and the business is protected from the lawsuit.

Avoiding Competition

When forming a holding company and a subsidiary, they might be in the same line of business. This helps to avoid competition by having them owned by the same corporation.

Simple to Expand

Holding companies are very easy to create and grow. This allows you to overall grow your business more easily than you would with only one business model.

Leverage Financing

Often having a holding company means one of your companies is larger or more stable than the other. This allows the larger company to obtain financing for the subsidiary, which may not have been possible otherwise.

Limited Liability or LLCs are the preferred business structures for most real estate holding companies. An LLC offers protection to the business entity and allows them to claim on the personal tax returns. To form an LLC, individuals need to file a COF or Certificate of Formation alternatively known as Articles of Organization. The certificate requires you to mention the state you wish to operate in. The entire process requires paperwork and attracts a fee that ranges from $50 to $200.

In most states, an LLC needs to be renewed each year by paying a nominal fee. Also, the company has to register for tax ID with the IRS. In case the company has to be made with additional members, it is important to draft an operating agreement that details about the management of the company.

The above graphic represents the most straightforward way of structuring your holdings. Additional protections can be gained through forming a separate property management company, equity stripping or holding your assets in a trust. The trust may either be a revocable land trust or an irrevocable asset protection trust.

Those desiring extra protection can create their own property management company or outsource this process to a third party. The management company is in charge of maintaining the properties, enlisting contractors, signing contracts with tenants and collecting rent.

Given the management company is the public facing entity, it is the most likely to be sued. This separates the potential liabilities of the above actions from the company holding the assets.

It does require an extra entity, though this is a relatively small barrier given the extra layer of protection it provides.

This is a more advanced technique which entails placing a second lien or mortgage against the property. The general idea is to create an entity which acts as your own personal bank. It provides a loan to the company holding the property and in turn places a second lien against the home as collateral.

This removes any equity from the home and means a potential creditor has nothing to gain by pursuing the company. This in itself can deter a great many lawsuits as attorneys generally prefer pursuing you only if there is a pot of gold at the end of the rainbow, so to speak.

Your holding company should be formed in one of four states, either your home state, Wyoming, New Mexico or Nevada.

Home State: This is the easiest, but not always correct, option. You can file your Articles yourself, act as your registered agent and opening a bank account will be easy.

Your home state, however, may or may not allow for privacy, could have higher taxes, higher fees and opening a bank account for an out-of-state company is not an insurmountable obstacle.

Wyoming: This state has quietly become the preferred jurisdiction for most small investors. This is because it allows anonymous companies, has no state taxes, low annual fees and nation leading asset protection. It also allows Series LLCs.

Nevada: This state used to be the favorite, however years of fee increases have caused its popularity to diminish. It offers very similar asset protection to Wyoming, but at a higher price. It also requires a list of owners, officers and managers be provided to the Secretary. These are not currently made public, but the Secretary is under increasing pressure to do so.

New Mexico: Cost conscious investors often favor New Mexico. This is due to their anonymous LLCs (corporations are not private) and the lack of an annual fee. After formation, you only need to maintain a registered agent. Those less concerned about asset protection prefer the lower annual fees and often choose here.

An added bonus is New Mexico recently began allowing online filings. This has reduced the average turn around time from nearly thirty days to less than a week.

After choosing your state, the next inevitable question real estate investors face is whether to create a Corporation or an LLC holding company.

Note, an LLC has the most tax flexibility. It is taxed as a passthrough entity by default, thus avoiding the dreaded double taxation, and can specifically opt to be taxed as an S-Corporation or traditional C-Corporation where it pays its own taxes. For this reason, your choice of entity should not be dependent upon the tax structure you want. Those are separate issues that should not be conflated.

A Limited Liability Company is easier to manage. It has fewer maintenance requirements and its Operating Agreement is relatively simplistic compared to the Bylaws and a Share Subscription Agreement of a Corporation. Fun fact, Wyoming was the first state to allow LLCs and now more than half of all new companies are LLCs.

Corporations are preferable if there will be a large number of investors, or if a complicated agreement is needed between owners. For example, if some owners should have voting rights and others none, or if some should just be able to vote, while having fewer economic benefits.

Series Limited Liability Companies have come into vogue as 13 states now allow them, including Nevada and Wyoming, but not New Mexico.

A Series LLC is identical to a traditional parent-child holding company setup in theory. There is an LLC at the top which has as many series, or children, below it as is deemed necessary.

The difference comes from not every state recognizing them. If a local judge is not familiar with the concept, then they will be more likely to treat all entities as a single company, thus pooling your risk and obviating the work you have put in.

For this reason, real estate investors should approach Series LLCs with caution if they have not yet been proven in the state they will be owning or managing property. For those that are in such a state, these are a wonderful option that can help reduce complexity and cost.

When the interests of real estate are placed in a property-holding company, it provides added protection to your assets and primary business assets. An example of why such protection is beneficial is illustrated below.

For instance let’s take the case of a real estate LLC that owns a restaurant. In case a customer by accident gets injured due to any property issues like a broken step, the customer is likely to sue the property owner. However, as the property belongs to a real estate holding company, the owner’s personal and business assets will be protected from the lawsuit.

Other advantages include:

• Limited Liability and Tax Benefits
• Establish Business Credit
• Business appears to a professionally managed entity with LLC at the end of its name

In general, there are two main disadvantages of a real estate holding company:

• Annual Costs
• Startup Costs

These costs of a real estate holding company can become expensive, and if you are not utilizing the company properly they may cut into your bottom line.

It is quite simple to start a real estate holding company.

1. Set Up an LLC

Although there are a few ways to structure a real estate holding company, an LLC is the most popular option. This is because it offers you liability protection and personal separation, while also allowing you flexibility and freedom.

1.1 Choose and Register a business name. You also need to choose the state this LLC will be operating in. You have to make sure that the name of the business is unique, and there is no such name that has already been registered. The business name should end in Limited Liability Company, LLC, or a variation that signifies the type of entity it is.

Each state has its own LLC office which is associated with the Secretary of State’s Office. To check if you have selected a unique name you may call them. You may also ask your lawyer to check online and verify if that particular name has already been registered.

1.2 File your Articles of Incorporation: Must be filed at the Secretary of State’s Office. It lists your company’s name and address, as well as the members of the LLC.

1.3 Create an operating agreement for the LLC. This agreement has to spell out the rights and responsibilities of each member. It also contains information about the voting structure, the interest percentage of each member, and how profits and losses will be managed.

Your LLC can have one or more members, and they will all be listed on the LLC operating agreement. It will define the role of each member and should be signed by each member. It must include the rules of operation and ownership, member percentage interests, rights, and responsibilities, as well as how profits and losses are handled.

1.4 Apply for an EIN or employer identification number with the IRS. An EIN is similar to a social security number for your business. The moment you have the business name and EIN, you have to file the paperwork to incorporate the LLC. In most cases, you will also have to file the articles of incorporation at the respective offices in the state.

The above steps are relatively simple, but it will be a good idea to consult an attorney to ensure everything is carried out smoothly.

2. Open a Business Checking Account

Before you begin operations, it will be important for you to create a business checking account in the name of your LLC. This way, you will be able to separate the funds for purchasing the property and your funds. The moment you have separated the funds, you are all set to search for and purchase a property.

It is important to keep your business and personal finances separate. When forming a holding company, you also want to keep each business account separate as well.

3. Work With a Professional to Set Up Your Holding Company

Although it may seem easy, depending on the structure of your business, it can get very complicated. Hiring a professional can ensure you will not make mistakes when it comes to setup.

4. Find a Property

The main goal of establishing a real estate holding company is to protect your assets and properties. This means you will need to go and purchase investment properties. Find one that fits your goals and budget.

5. Obtain Financing

Financing may include your own cash funds, a loan, pulling a loan from your parent company, or getting general financing from a lending institution.

6. Close on the Property

At this point, you will be closing on the property which means you pay closing costs. Finally, you will have your real estate holding company set up, and can continue to purchase properties to add to its portfolio.

In general, the costs of starting a real estate holding company vary by state. The average state filing fee to set up an LLC is $127 if you are doing it yourself, while the average cost to set it up with an attorney is $1,000 or more. The typical costs required to set up an LLC include:

• State filing fees: Range anywhere from $10 – $800 as a one-time fee.
• EIN number: Always free, similar to the social security number for your business.
• Annual LLC fees: Anywhere from $0 – $800, depending on the state.
• Operating Agreement: $20 or more for a template.

Market Risks

It consists of the ups and downs connected to the economy, inflation, market trends, and interest rate fluctuations.

Asset-Level risks

The risk is proportional to the type of assets owned. Apartments are considered to be low-risk investments, but office buildings come with high-risk investments.

Idiosyncratic Risk

Related to a specific type of property, higher the risk more is the gain. Construction is an example that adds risk to a project as it limits the capacity to collect rent during that period. Entitlement and environmental risks are the other major idiosyncratic risks that can impact returns from real estate investment.

Structural Risk

Not related to the actual structure of the building; it is the investment’s financial structure and rights offered to an individual participant. For instance, the structural advantage is higher in the case of a senior secured loan in comparison to subordinated debt or mezzanine. This is because the former has to be paid first.

Liquidity risk

Areas like Evansville are easy to invest compared to places like Houston. On the contrary, Houston will be able to attract a larger number of buyers, and it will be possible to sell off a property much quicker than Evansville.

Credit Risk

Stability and length of the income stream of any property offer more value. A property leased to a multi-national company for 2-3 decades will command a comparatively higher price

Replacement cost risks

With the increased demand for space, the lease rates in older properties tend to grow up. However, it will not sustain for a considerable period if those lease rates are not justified at par with new construction and increased supply.

Leverage Risks

Risk increases with the debt involved in a particular investment. Leverage acts as a force multiplier that can move the project quicker besides increasing returns if things go well. On the contrary, if the loans are under stress, especially when the returns on assets aren’t enough to cover the interest payments, an investor loses quickly and in large amounts.

If you plan on investing in real estate and you already own one company, it may be a great idea to start a real estate holding company. This can allow you to conduct and manage your real estate investments while reducing your personal exposure to risk and liability. Contact us today to get started and learn how you can reduce your liability and start your own real estate holding company.

Generally, fit for both long term, and short term investors, a real estate holding company apart from above advantages, is an inexpensive organization to manage. The costs and commitment are nominal against the benefits. This type of company is perfect for Fix and Flippers, Long-term investors, commercial investors, real estate investors, first-time investors, and landlords.

On the flip side, it is not advised if you are merely purchasing a home as your primary residence. In this case, an LLC will be costly and require high maintenance. Thus ensure you keep the primary residence in your name.