Please note: This article is not legal advice. For up-to-date information and guidance, reach out to your attorney or Real Property Associates.
When you don't own multiple rental homes in Seattle, you may think the easiest option for handling expenses and taxes is to have your Seattle property management company provide you with the necessary paperwork you need. However, you're still missing out on a crucial form of protection for your real estate investments: the right business entity.
Once you begin investing in multiple properties and your operational expenses increase, you're already beyond the point where you should be considering forming a real estate entity. If you're reading this article, you're likely either considering forming your entity or trying to decide if you need one. If you have even a single rental property, it's the right time for a real estate entity to protect your assets! However, to experience that protection, you need to form the right one.
The right real estate entity technically 'owns' and manages your real estate investments and separates them from personal belongings. While all properties can be managed separately, all income, losses, and taxes must be shared within the entity. Essentially, this protects you from personal liability.
Why Choose a Real Estate Entity for Your Rental Properties?
- The right real estate entity keeps your investment separate from your personal belongings.
- This limits your exposure to personal liabilities. It also helps you manage your finances more efficiently.
- You will benefit from specific tax deductions and benefits such as pass-through tax deductions for certain forms of business entity. This has the added benefit of preventing double taxation.
If you want to get really deep into sheltering yourself from loss if you have multiple investments, you can even work with your attorney to set up a different entity for each of your real estate investments.
Forming a separate entity for each property limits liability claims to that company and that Seattle rental property alone. This way, if somebody files a lawsuit against one of your properties, the rest are not affected by the outcome.
How Can You Select the Right Business Entity?
- Most Seattle investors that aren't acting on behalf of a fund choose to establish a Limited Liability Company (LLC) as opposed to C and S corporations.
- This is because forming an LLC does not require as many formalities as the other alternatives. For instance, C and S corporations are required to hold annual general meetings, a rule that does not apply to LLCs.
- LLCs are more flexible in their management and have better tax benefits while still sheltering your assets from liability—as opposed to a Sole Proprietorship, which does not.
The Basics of a Limited Liability Company
- An LLC combines the elements of a sole proprietorship, partnership, and corporation.
- The biggest perk of forming an LLC for your rental properties is that you will be covered against personal liability.
- Also, your personal assets will be protected in case of a lawsuit or extreme loss.
- By setting up an LLC for your rental properties, you will also benefit from pass-through taxation.
- This means that corporate taxes do not apply.
Rather than filing separate tax returns, any losses or profits are reported on the owner’s income tax statements directly.
If you are considering partnering with a foreign or domestic investor in the future, forming a Limited Liability Company would be your best bet. However, you'll need to have an Operating Agreement in place.
The legalities of any business entity are why we strongly recommend seeking advice from an attorney or guidance from your Seattle property management partner.
Simple Information on C Corporations
Unlike LLCs, C Corporations are required to:
- Have a board of directors
- File the appropriate incorporation documents
- Have a list of shareholders, and assign each of them the number of shares they wish to invest.
With the introduction of shareholders, the company’s ownership is shared among shareholders. The shareholders also share any profits and losses.
Quick Details About S Corporations
Just like C Corps, S Corps must file appropriate documents and have a board of directors. However, S Corps' shareholders must not exceed 100 people. All the shareholders must also be US citizens or be legal residents of the country. Some of the other requirements needed for a company to obtain S Corp status include:
- Have allowable shareholders who may be individuals, estates, and trusts, but not corporations or partnerships
- Have one class of stock
- Be an eligible corporation such as an insurance company, financial institution, or an international sales corporation.
An S Corp must also submit Form 2553 that is signed by all shareholders. As you can see, any of the corporate forms of a business entity aren't typically ideal for individual investors without plans to become beholden to shareholders in the future.
Which Real Estate Entity Is Best for You?
Your choice will depend on such factors as the number of rental homes in Seattle that you own, where you are located, your ambitions, operational capability, and plans. As mentioned, most investors prefer setting up LLCs; hence, variations of the same are the most common.
However, trained professionals, including your accountant, attorney, and Seattle property management company are best placed to advise you on which option will support your financial goals. Not only will they advise you on any legalities of opening a real estate entity, but they are also experienced in how to handle tax matters.
Important Expenses to Consider for Real Estate Entities
Just as you would with any rental property, you need to consider the ongoing operational and maintenance costs of your business entity of choice.
- Apart from the initial capital, you may also need to pay annual renewal fees (among other charges) that will keep the entity in good standing.
- You may also need to keep records or necessary forms that must be reviewed, maintained, and signed annually. In the case of an S Corp or a C Corp, you must maintain records of annual general meetings.
When viewed objectively, the benefits of setting up a business entity tend to outweigh the drawbacks. The complexities of being an investor with multiple properties can be overwhelming. Why not let a skilled Seattle property management company assist you?
Setting up the right real estate entity is just one of the many elements of growing a successful real estate portfolio worth considering. Learn more when you download your free copy of our guide to real estate investing in Seattle!