Colorado Real Estate Journal - August 17, 2016
As a Denver area attorney specializing in helping real estate investors tackle the tough issues associated with holding investments, one of the most common questions I am asked is how to best protect clients’ personal assets as well as the investments they hold. While adequate insurance is a good start and a critical piece to any asset protection plan, there are significant planning opportunities associated with using limited liability companies and other business entities to hold and manage assets. And while one size rarely fits all, there are some common threads associated with real estate that can assist and inform a savvy real estate investor to move in the correct direction. What structure is best? LLCs. Corporations. Limited partnerships. Joint ventures. An investor can easily reel thinking about the possibilities and what would be best. I could write an entire series of articles concerning the different entity types and their uses, but I’ll just keep it simple here. LLCs by and large are easier to run than corporations and so are the type of entity that I most often use when structuring businesses for my clients. The most poignant example of the relative difference between the formality associated with these two entity types concerns company meetings. Corporations have shareholders, a board of directors, officers, and each and every group must meet to discuss company business, vote and otherwise conduct business in a very formal manner. LLCs, on the other hand, are much less formal. In their simplest form, instead of the numerous roles associated with corporations, LLCs simply have members. The members of an LLC still should meet and discuss company business, but when compared to a corporation there’s only one meeting necessary for the members of an LLC. A corporation, on the other hand, would require two or three – one for the shareholders, one for the board and possibly even one for the company’s officers. Using the example above, it’s easy to see why an LLC would be the entity of choice for most investors. And if an LLC is run correctly and with an eye toward formality, there is good case law to suggest that an investor’s personal assets will be protected from creditors largely the same as a corporation (though you should be wary of single-member LLCs). A word on tax structuring. So let’s assume that you’ve agreed with me and decided an LLC is the way to go. A quick word on tax structuring for LLCs: The tax code was written in 1986 and LLCs were largely a creature of the early 1990s. When LLCs came on the scene, Congress didn’t just rewrite the tax code. Instead, the IRS created regulations that essentially say that the person creating the LLC can tell the IRS how they want the LLC to be taxed (within certain limitations). So a multimember LLC, for instance, can be treated as a partnership, a C-corporation or an S-corporation. Now let’s back up for a second and let me give you a quick caveat: Everyone’s tax situation is different and I’m speaking in broad generalities here. You should speak to your tax professional about what would work best for your particular scenario. But generally speaking, for rentals I would recommend an LLC taxed as a partnership and for fix and flips, property management, brokerage income, and/ or wholesaling generally, I’d recommend an LLC taxed as an S-corporation because the S-election can generate significant savings on self-employment tax. What about an out-of-state company? Often new clients will come in the office for a consultation and they’ve been sold on the idea that they need an out-of-state company. They’ve heard about the advantages of incorporating or organizing in a state like Delaware, Nevada or even Wyoming. And while it’s true that these jurisdictions sometimes have more favorable laws relating to the amount of asset protection a business owner will receive, the real question is whether going out of state when your asset is in state will afford you any benefits. Without getting too involved (there is an entire field of law relating to the conflicts of laws and what law will apply in any particular suit), the basic rule that I share with my clients is that if you are doing business in Colorado, and particularly if you own property in Colorado, it’s an almost sure bet that Colorado law will apply regardless of which state your business is formed in. So if we created the company out of state, it is more likely than not that the client would not even benefit from the beneficial laws of the other state anyway. So the investor most likely won’t benefit from the laws in the other state. To add insult to injury, the law in most cases also will require that the LLC still register to do business inside Colorado with the Colorado Secretary of State, meaning that the business owner will need to pay the Colorado Secretary of State and the other state’s secretary of state on an annual basis. By the way, did you know that Nevada’s annual fee for an LLC is $125 and the business license is $200? Colorado, on the other hand, is $10. Nevada’s fee is an awful lot to pay when it’s very likely you won’t even benefit from its laws. Did you pass the checkup? If you’re new to investing or you haven’t started structuring your investments using business entities, it’s never too early to start and I recommend getting started right away. But if you have already structured your investments in business entities, how did your structure hold up in light of the information I’ve shared above? Are you paying unnecessary secretary of state fees? Are your entities set up correctly to help save you money come tax time? Can you give your asset protection plan a clean bill of health? If you’re just not sure that your structure passes the check-up, consult with legal counsel and ensure your investments are both well protected and helping you save as much money as possible.