Best Entity For Real Estate Investing – ( LLC or ? For ACTIVE or PASSIVE Rentals )

Best Entity For Real Estate Investing – ( LLC or ? For ACTIVE or PASSIVE Rentals )

– Hey guys, Toby Mathis here. I’m one of the attorneys with
Anderson Business Advisors. And I wanted to talk to you
today about the best entity. (theme song music) Subscribe to the YouTube channel, click the bell notification icon so you know when a new video is uploaded. Tax laws are changing all the times, the laws are changing all the time, that’s why you’re first to
know, you’re first to grow. So, I’m actually gonna write this out. I’m not big guy on writing, but I’m just gonna say best entity for real estate. And I’m gonna leave this very broad, and you’ll see why in just a second. So the first off, is any time you’re investing in real estate, you’re gonna fall in
one of two categories. You’re either actively
involved in real estate where you’re doing
things like wholesaling, I’m a real estate agent, I’m a developer, I’m a builder, things like that. Or I am a passive investor. And those are you guys
who are really savvy, already know you’re gonna say it, hey Toby, there’s the
passive activity rules where there is exception to that, which is if you’re a
real estate professional. I’m not gonna get into that. What I’m gonna say is that
there’s really two big categories and so we’re just gonna draw big. And one of them is active, and one of them is passive. And the easiest way to understand this is an active person,
it’s what you’re doing, it’s sweat of your brow. In other words, if I don’t do anything I don’t make any money. So, a real estate agent,
a developer, wholesaler. So, I’m gonna say wholesale, agent, developer, construction. All that stuff is active business. In other words, I’m actually physically putting my labor into it and therefore, it’s treated differently
than if I’m over here on the passive side. And the passive side is just
buy and hold real estate. So, this is rentals. And it could be apartments,
it could be commercial, it could be whatever, it’s
just I am not doing the work. The rental is doing the work for me. So here, whether I get up in
the morning and go to work or not, there’s money coming in. The real estate’s doing
the activity for me. Now the reason this is so
important is because this one, this active right here, is subject to something
called self-employment tax. So, if I am a real estate agent,
so I’m doing it in my name. I’m gonna be called what’s
called a sole-proprietor and I would not advise it, first off, but let’s just say that I’m doing that. Then I am subject to
something called old age, death and survivors, and Medicare commonly known as the self-employment tax, or Social Security,
however you wanna call it. It adds up to being 15.3%. There is a deduction on half
of it, so the actual math is if you’re under
133,000 or so, it’s 14.1% that you’re paying. That’s a pretty big chunk. That’s not talking about
your income tax either, your state or your federal. That’s just the extra penalty tax that does not exist over here. Now, there are some ways
to avoid that over here. You could use a corporation, for example. An S or a C corp’s gonna do
the trick on a portion of that. Most people use S corps
because they need to live off the money that they’re earning over here. But that’s not always. I’m just bringing that
up because there is a way to eliminate or reduce
that self-employment tax. There is no way to do it
if you’re just operating as a sole-proprietor. So that’s first off. So, we could say, don’t
be a sole-proprietor. You always wanna make sure
that you’re structured in some taxable entity
whenever you’re involved in active businesses. Now the passive side’s
a little bit different. Because passive, I’m just gonna
put a big plus next to it, you get all sorts of benefits
from passive activities. First off, there is no self-employment. There is also something
called a 1031 exchange where you can trade the money, trade the assets for more assets and you don’t actually
have to pay tax on it. That’s called a deferred exchange, so in theory you pay it eventually. But if you never sell the asset, you keep it ’til your
dying day, the basis steps. So you could literally avoid
paying tax through this. You also have depreciation. You have the ability to
do installment sales. There’s all sorts of stuff, installment. Heck, I could even do (mumbles). And there’s so many benefits that, here I’m writing off the board, so I’m gonna call it a (mumbles). There’s so many benefits there
that I can actually utilize by being a passive entity. Now here’s why this is really important. Because when you’re
choosing the type of entity, when you pick an entity, you don’t want to destroy those advantages if you can avoid it. And there are certain types
of entities that you can use. The most commonly used
one is gonna be an LLC and that LLC is gonna be taxed either as a disregarded
entity if it’s just you, or it’s gonna be taxed as a partnership. You’re probably not gonna be
looking at any other options other than that. In fact I can pretty much tell you that for real estate investors, we’re almost always going to an LLC. Now some of you guys are
big land trust buffs, and I get it. That by itself doesn’t provide
you any asset protection. And so, I’m gonna kind of go
over these three categories that you look at whenever
you’re doing an entity. Whenever you do an entity, I’m gonna be looking at the state. I’m gonna be looking at third parties. And I’m gonna be looking at the IRS. And I’m just gonna put
those into categories. And this is actually,
if you break it down, and any practitioner
whether you’re a lawyer, an accountant, or anybody else, go ahead and steal this
because this is the easiest way to understand it. In a state, I can have
something called an LLC and I’m not gonna jump into series LLCs, I’m not gonna jump in,
but from a state level, I just care that I have a vehicle that isolates the liability. And so what I care about
is putting a box around whatever the liability is. If I am a plumber and I wanna
make sure I never get sued in case something happens
on a job that I work on. Maybe I break a pipe in somebody’s house. I need to operate through,
you got it, an entity. If I have real estate, I wanna make sure that if a tenant falls down the stairs it doesn’t cost me everything else I own. So, that’s called inside liability. It stays inside this little guy. The state is who you
pay to get that benefit. So, I’m actually paying the state and saying please give me some benefits. And the state, and again we
have 50, so we can choose. But wherever the real estate
is held is more than likely that’s where I’m gonna
be sticking my entity for holding this thing. But that state, I’m paying them money and they’re saying, here’s
benefits of a statute that you can now use to your benefit that’s gonna keep the
liability inside that thing. But there’s also me. I’m sittin’ out here. That’s called outside liability
and that’s also important. When we develop an asset
protection plan at some point, we wanna make sure that somebody cannot, I or maybe it’s one of
my kids or something, gets into a car accident
and all of a sudden I’m looking at getting
everything I own taken away. Whether or not they can take away that LLC and there are states where
they cannot take it away. And so, we usually are putting
our real estate in here, but we may put another box
around even the real estate, we call it a holding company. And it would hold all of my other LLCs. But for now, I’m just
gonna focus on the fact that we can create a box. We can put our real estate in that box and that’s where the liability stands. Then we have third parties
we have to deal with. And this is your judges,
lenders, your bankers, your hard money lenders. All those things fall into this category. Anybody, any shareholders
that I’m dealing with or other members in my LLC. This is where I’m gonna have a contract. I need to make sure that
I’m doing this part right and this is where people
usually goof up, by the way. It’s in that operating
agreement or other agreements. So if you can read my writing, just call that an
operating agreement or OA. If I’m dealing with a lender, they’re gonna want to see that. If I am, maybe I buy a property and then I put it into the box. Maybe there’s no lender
that’s actually seeing that. If I do that I may use
one of your land trusts again, those land trust buffs out there. Land trust does not
provide asset protection. It just is a good thing
for disguising title. So, we’re just looking at
the third parties there. That’s our operating agreement
and that’s the body of it. So you kind of think of like this, if I don’t do this and I don’t do this it flows through to me. So it’s my body, they
can attack my assets. It’s really just me. If I do this, without doing this, so if I actually file with the state but it doesn’t have a body,
it’s gonna defer to the statue, which is gonna flow down to me. So I need to make sure
I’m doing both of these. And then this last category
is the most important, and this is where people screw up. I could be a sole-proprietor,
I could be a partnership, I could be disregarded,
I could be an S corp, I could be a C corp, I could
be any of those things. An LLC is not a tax designation. So, if you ever hear people
say, hey, how are you set up? And you say, well, I’m an LLC. Well, how are you taxed? And if they say an LLC,
you can make fun of ’em. No, you just say, hey,
there’s no such thing as an LLC tax as an LLC. You have to tell the federal government, you have to tell the IRS what is it. Should we ignore it and
just look at your return? Hey, it’s going on my 1040 Schedule E. Is it, hey, it’s gonna
be treated as an S corp, okay, then it’s gonna go on a 1120 S. Hey, should we treat it as a C corp? Okay, then it’s gonna go on a 1120. Is it gonna be taxed as a partnership? Great, it’s gonna be a form 1065. So, all of those things we’re lookin’ at. By the way, some of you guys are, again, I know there’s some tax nerds out there. They’re going, hey, what if
a corporation owns an LLC that’s disregarded? Yeah, then it goes on
the corporate return. All right, but the point is is
that the IRS needs to be told how to treat it. Now, if we have real
estate, and it’s this type of real estate, then we’re
gonna put it in an LLC with an operating agreement that is more than likely disregarded or taxed as a partnership
because those two things keep all of these benefits. Whereas if we put it in one
of these, we could lose it. We probably aren’t gonna
be an S or a C corp for purposes of investment property. We’re gonna be an S or a C corp only if we’re on the active side. And if we’re on the active
side, then we wanna make sure that we’re keeping it
off of our tax return to avoid the self-employment
tax automatically. We could still have an S
corp flow onto my return. I could still take a
portion of that as salary and pay a little bit of Social Security, but on everything else,
on all the distributions out of that, above that
amount, I avoid it. And it saves you, in my experience, I have 20 something
years experience in this, it’s about somewhere
between 10 and 15% a year on how much it’s making. So, there’s a pretty big spread when you’re looking at the typical case of somebody who’s running
their real estate agent, who’s a wholesaler, who’s a developer or construction company, you’re usually gonna be setting that up. Again, our default’s
probably gonna be an S corp and then maybe sometimes
we look at a C corp and maybe we layer it. Sometimes you’re lookin’ at it saying, hey, could I actually use two
or three different entities? Yes, you can. And it has to make sense. This has to make economic sense. So, getting back to the original question, which is the best entity
for real estate investors. Here, I’ll get rid of that little line. Our actual answer. So, if you’re a real estate investor or you’re an active real estate person who’s a wholesaler, an agent or something, it’s more than likely
it’s gonna be an LLC. And then you choose
how it’s gonna be taxed and you make sure that you
document that appropriately. I hope this helps you
make better decisions. If you need help in this,
obviously give us a call. This is something we specialize in and we love working with
real estate investors and people that flip,
wholesalers, agents, you name it. We’re used to dealing with it and we’re used to compartmentalizing
certain types of risk. You just use the little boxes
and it’s kinda like magic, you get the benefits. You pay the state and you say, all right, what are the benefits I can get? But somebody who is working with you needs to be experienced in real estate and needs to be looking at these things and be able to articulate the difference so that you don’t walk into a problem by sticking this in the wrong business or taking a rental and losing benefits. Again, if I ever see
another rental property, stockpile of properties
where somebody’s investing and they’re all sitting in a corporation, and I have to explain
when they take it out it’s treated as wages. You know, it’s like, whoa,
you transfer that asset out you’re gonna get nailed. You’re gonna basically have to hold that until you pass away
and then basis can step and we can remove it. But it’s a pretty big negative. If I see that again,
I’m just gonna go crazy. Gonna say obviously you’re
not watching our videos. But that’s not gonna be you ’cause here you are watching this video. But hopefully we can help ya. If you have questions, give us a call. Again, my name’s Toby Mathis and it’s always fun to try to figure out what’s the best entity for real estate. (theme song music)

3 thoughts on “Best Entity For Real Estate Investing – ( LLC or ? For ACTIVE or PASSIVE Rentals )

  1. Good info. Thanks!

  2. For flipping & hold 2 properties, what to applies in St. Louis MO. ?

  3. Finally I get a straight answer on this! I've asked this question countless times and have never had it explained this effectively. Thank you!

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