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.
Frequently Asked Questions
The primary reason not to register the LLC yourself is the
privacy aspect. We have clients call us every week who tried to
save a few dollars doing it themselves. They quickly found out
one mistake cost them more than money. Having us set up your LLC
also provides you with a number of important documents and a
help line in case you have any questions.
There are other providers. However, most of them tend to be
large national incorporation companies. They charge more, take
longer and care less than we do. Some of them are simply just
resellers of local incorporation and virtual office providers
such as us. There are no call center employees here, nor will
you ever be passed off from one person to another.
The new tax laws bring benefits for pass through entities such
as LLCs. For many, these savings cover the cost of formation.
Limited liability companies have the most flexible taxation of
any business entity. By default, they are taxed as pass through
entities and not subject to double taxation.
This means the company's earnings flow directly onto your
personal income statement and the company does not file its own
tax return or pay taxes. This is something those selling Wyoming
LLCs and Nevada LLCs do not tell you... you cannot actually
benefit from their lack of state taxes because where you live
determines the tax rate.
Forming a limited liability company can both reduce your top
line tax rate and increase the number of deductions you are
eligible for, regardless of where you organize your company.
These benefits make it even more disadvantageous to operate as a
sole-proprietorship. Learn more here about New Mexico LLC taxes.
Only a few states actively compete for new business formations.
You will commonly see these states touted online as a great
place for e-commerce companies, real estate investors and
holding companies. Each goes after its own share of the market
with Wyoming and New Mexico being favorites for their low fees
and privacy. Find which state is for you on our page comparing
LLCs in New Mexico to Wyoming LLCs, Nevada LLCs and Delaware
LLCs.
An operating agreement sets the rules for the company and should
be signed by every member. If there is one member, then the
agreement is relatively simple. This is because the member needs
to establish a few guidelines, but does not need protection from
other members.
For multi-member LLCs an operating agremeent is more important.
It defines the rules each owner and manager must follow, plus it
defines the ownership percentages. It is important to establish
these early on. Imagine waiting a few years down the road, after
loans and distributions are made, without writing down who owns
what.There will be transfers in and out, memories will fade and
the judge will have a hard time determining who owns what
percentage. While dramatic, this highlights the risk of not
signing and updating your agreement.
The next questions is whether to choose a Member Managed
Operating Agreement or a Manager Managed Agreement. This is a
question of who manages the company day-to-day. Either the
members (owners) or a manager(s) elected by the members. The key
difference is in who makes daily decisions for the company, e.g.
signing contracts and opening a bank account. Note, members may
elect themselves as a manager if other partners want to remain
silent. Follow our link to learn more about New Mexico LLC
Operating Agreements.
An EIN is required if you are going to do business and enjoy the
benefits of the LLC. A single member LLC may decline to obtain
an EIN, but then all of the company and personal accounts will
be linked. This lack of separation could create serious asset
protection issues down the line. It also makes it harder to
obtain the tax benefits listed above.
For these reasons, we advise every client obtain and EIN and
open a bank account in the company's name. You may follow our
free EIN guide (located in the "Resources" tab of the navigation
bar), or you may have us obtain it for you.
The idea behind the corporate veil is that a company is separate
from its owner. The company may enter into contracts and assume
debt. This separation helps protect the owners personal assets
from business creditors. A corporate creditor cannot "pierce the
veil" and go after the owner's personal assets.
You receive everything needed to start doing business. Through
our portal you receive Articles of Organization, an Operating
Agreement, Resolution to Open a Bank Account and more. We
complete these document using your information. Other providers
often supply templates which you must fill out. All of our
documents are ready to print and sign! The way it should be.
New Mexico's Secretary of State has no requirements outside of
maintaining a NM Registered Agent Service. This is the only
thing required to avoiding having your New Mexico LLC be
dissolved.
A sole-proprietorship is when you run a company using either
your personal name or just a DBA. Sole-props pay MORE in taxes
and have no corporate veil. This means if there is an accident
or bad debt then you are PERSONALLY liable. Even seemingly
simple hobbies would do well to consider forming a limited
liability company. Even if you are the only owner, there are
good reasons to form a New Mexico Single Member LLC.
Single Company
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.
Holding Companies
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.
Traditional Holding Co Graphic
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.
Property Management Companies
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.
Equity Stripping
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.
Where to Domicile
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.
LLC Holding Companies vs. Corporations
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 LLCs
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.
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