There are so many different ways to form a company, it can make your head spin.
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As an entrepreneur you are probably familiar with this. For many entrepreneurs, you may have started doing business simply in your own name – as a sole proprietorship. But as many companies grow, the benefits of forming a corporation or a limited liability company become evident. The main advantage is that it allows you to separate out liability related to your business from your personal assets.
Limited liability is important because in business, often times things happen that are beyond our control. Market swings can easily disrupt and even bankrupt the most perfectly executed business plan. By creating a limited liability company or corporation you can protect your personal assets (your home, your retirement, your personal savings, etc) from any business failures.
If you are considering buying real estate, not as your core business but in order to run your business, I suggest that you follow the same course and create a separate limited liability company (LLC) to hold each individual real estate asset. Here's why:
Real estate is great because it acts as its own security. If you took out a small business loan to start your company, you might have had to get some kind of guarantor to sign, or something of that nature. For real estate you usually don't need that. Because the building has value in and of itself, it can serve as the collateral for the loan. Take advantage of this and limit your risk by placing the real estate in a separate LLC which secures and services the loan. Good legal counsel and accounting advice can help you set up the LLC so it is managed by your primary business.
Another reason to hold the real estate in an LLC is called recourse. Most lenders place clauses in your financing agreements stating that they have recourse. This means that they can take the primary asset (the building) if things go bad, but that they also have rights to any other assets held by that ownership entity until they have been paid in full.
In order to limit the bank's recourse, you should have the LLC you form to hold your real estate stand alone and hold only that piece of real estate. Also, have your legal counsel ensure that the bank's recourse is limited to that LLC and its assets. This will protect you from the bank coming for other assets you own in the event the building goes bankrupt.
This method is used by many real estate companies, especially private developers. Some of them will have as many as 250 limited liability companies, each of them holding just one or two real estate assets and each of them with separate financing. Doing this keeps any damage under control. A catastrophic issue at one building will not bring down the portfolio.
Naturally, there is one drawback to holding your real estate in this manner. This will complicate your taxes. Consult a CPA before forming this LLC and plan out how you will handle the tax situation. There are numerous tax issues relating to real estate, and you want to be informed of them in advance. There are numerous companies out there who specialize in real estate tax, so consult one before you make your purchase.