What is the Purpose of a
Real Estate Holding Company?
Real estate is a popular investment with unique risks. The potential liabilities do not mean you shouldn't invest in real estate, but rather you should take the proper precautions. This means not only insurance, but forming an llc, and likely a real estate holding company with subsidiaries as you grow.
A proper holding company structure not only minimizes risk, but provides privacy and tax savings. There is no reason to make your assets public, for example would you post bank account numbers on Facebook? Of course not, and so an anonymous LLC is generally best. Further, the government incentivizes business ownership and long term investments - which means there are tax benefits to holding real estate in an LLC.
In short, a holding company provides asset protection, privacy, tax benefits and makes you appear more professional. The question becomes how should you set one up and in which state? More advanced strategies will include using land trusts, equity stripping and property management companies. These will be discussed below as well.
How Do You Structure a Holding Company
A holding company can be defined in a few ways. The two most common are either as an entity meant to hold an asset, or a parent company meant to hold children companies (also known as subsidiaries).
Generally, a holding company (the parent) will be established in a business friendly state such as Wyoming, New Mexico, Nevada or Delaware. Children companies are usually then formed in the state where the property is. Each property should have its own company to avoid an accident or lawsuit with one property from affecting the others.
In this structure you form a parent company to hold other companies. The companies below it are then formed to hold properties. A property management company may optionally be used for additional asset protection and tax benefits.
In each case, the companies are formed for a single purpose. The parent company only owns other companies. It does not engage in operations or other risky activities. The children companies own a single piece of real estate. This separates your business assets from each other, and your personal assets from business risks.
Should a Holding Company be an LLC?
Limited Liability Companies have become more popular than Corporations because they are easier to manage, provide better asset protection and have more tax flexibility. Wyoming LLCs, unlike Corporations, provide charging order protection even when there is only one member. This means personal creditors cannot break into your company and force you to liquidate real estate assets.
A little known fact is that LLCs can also be taxed as either a disregarded entity, Partnership, Corporation or an S-Corp. This means an LLC holding company has more tax flexibility, and benefits, than a traditional Corporation.
Creating an LLC involves filing a document known as the Certificate of Formation or Articles of Organization. This is filed with your Secretary of State and will include both a fee and paperwork. Depending on the state, the fee tends to be between $50 and $200. Most states require annual renewal of LLCs, along with paying a small fee. LLCs will also apply for an IRS tax identification (EIN) number. You should also draft and operating agreement and have each owner and manager sign.
Holding Company Examples
We find providing examples can be more beneficial than speaking abstractly about a subject. For that reason, this section will be dedicated to providing example uses of holding companies. Our hope is to make the concepts here more clear than by simply speaking about them abstractly.
The simplest example is if there is a single property. In this case only one LLC is generally used. The LLC owns the property and you either manage it via the LLC or have a 3rd party property management company.
If there are two investment properties, then they should each be held in their own companies. These companies are in turn owned by a holding company. The parent company does not engage in operations, it simply owns the children companies which own the properties. This separates the properties from each other, and provides a second corporate veil in case there's an accident. The person suing will have to break through two companies to attack your personal assets.
When there are many properties you may begin considering using a separate property management company. This may be either a company you form, or a 3rd party. This helps to push the risks of property management away from the companies which own the real estate. Equity stripping and land trusts may also be used for additional protection and privacy.
Many real estate investors begin by purchasing homes in their name, only to later realize they have significant assets, and risk, by holding real estate this way. Beginning with the correct structure helps prevent headaches later on when you realize property must be transferred to an LLC to remove it from your name.
Advantages & Disadvantages
We have primarily covered the advantages of holding companies above. There are some disadvantages to be aware of, but we do not believe they are significant enough to warrant using a single LLC for every property or operating as a sole-proprietorship.
The formation process will come with costs, including for registration. There will also be ongoing costs, such as any annual fees and your business taxes.
Holding companies also require management, and business owners with less or no experience may find this daunting. To get around that issue, you can hire an attorney with experience dealing with holding companies.
While there are disadvantages, we do not believe the seeming simplicity of operating a sole-proprietorship makes it a good choice. Sure, there are no extra forms to file, or ongoing fees, but a single accident can put everything, including your personal assets, at risk. For this reasons the advantages of a holding company outweigh the disadvantages.
How to Create a Holding Company
If you have decided to protect your real estate assets with a holding company, you will want to begin by setting up your LLC. This involves selecting a name, registering the company with your Secretary of State and the IRS, and getting your employer identification number. To ensure you complete the paperwork correctly, it is best to work with an attorney who has experience in holding companies and real estate. The process will include filing the Articles of Organization and drafting the Operating Agreement.
Next, you will need to open bank accounts for the LLC that are separate from any personal accounts you have. This assists with both bookkeeping and protection of your assets. After everything is ready, you can begin purchasing properties with the property you choose varying based on your goals. Some real estate investors will buy then hold property for rental income while others will flip properties. You will also need to secure the financing for the property, which will be done in your holding company’s name. Finally, you close on your chosen property, once again using the holding company’s name.
The process of setting up and using a holding company for real estate can go more smoothly with the assistance of an attorney, but it will increase up-front costs slightly. This is typically worth it in terms of long-term savings and efficiency.