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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.
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.
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.
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.
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